What is net profit? Definition, formula and examples

Table of contents

• Net profit definition
• Why is net profit important for my business?
• Net profit formula
• How to calculate net profit
• Examples of net profit
• Gross profit vs net profit
• FAQs on net profit

Key takeaways

• Net profit is profit after all expenses and taxes
• The formula is: Net profit = Gross profit – operating expenses – interest and taxes (and depreciation and amortization, if they apply)
• To increase profits, you must decrease expenses or boost revenue
• Calculating net profit helps you judge your profitability, and for all kinds of profitability margins – for example, how much of your revenue becomes profit.
• Net profit and gross profit are not the same.
• Gross profit is the difference between revenue and cost of goods sold (COGS), while net profit is your gross profit minus operating expenses, interest, and taxes.
• Tracking net profits helps guide decisions about your business's growth and operations.

Net profit definition

Net profit is the amount your business earns after covering your operating expenses, accounting for your non-cash costs (such as depreciation and amortization), paying interest paid on debt, and taking out taxes. It’s the amount that stays with the business once all costs are accounted for.

Net profit is also referred to as net earnings or net income. Many people call it the bottom line – because that's where it appears on the income statement.

Why is net profit important for my business?

Net profit shows you how much your business earns. It reflects your overall financial health and operating efficiency, and determines how much you have to reinvest or distribute to owners. High net profits can help you attract investors or get loans – the more profitable your business is, the easier it is to get outside financing.

Why gross profit and net profit both matter for your business

When people talk about profit margins, they're usually referring to net profit margins. But gross profit margins can also be critical – especially in retail, manufacturing, or other businesses with significant COGS.

Taken together, gross and net profit reveal why your business is profitable or not, and what you should do about it. By calculating both these numbers separately you can better see where to cut costs, and (by using these numbers to calculate profitability ratios) how well your business’s spending translates into profits.

Calculating your net profit

The net profit calculation is fairly straightforward, but you’ll need to do some intermediate calculations to fill in the elements of the formula.

Here’s the net profit formula:

Revenue, COGS, and gross profit make up the first few lines on your income statement.

The net profit formula

1. First find gross profit by subtracting the cost of goods sold (COGS) from your revenue.

• Starting with revenue, how much has your business earned from sales and other revenue sources, like interest on savings accounts? Let's say it's $250,000.
• Then, what are your COGS? How much did it cost to buy or produce the items you sold? Let's say you spent $100,000 buying inventory or supplies to make items.

To get gross profit, subtract COGS from revenue:

$250,000 – $100,000 = $150,000.

2. Then subtract the rest of your operating expenses, interest, and taxes. Depending on your business, your expenses might include rent, utilities, wages, credit card processing fees, and travel expenses.

3. Subtract your interest and taxes

4. And if it’s the end of the year, account for depreciation and amortization (ask your accountant if you’re unsure).

The resulting number is the bottom line: your net profit.

Once you have net profit, you can easily find your net profit margin – the portion of each sale that goes toward the bottom line. Check out Xero's net profit margin calculator to crunch your numbers.

There’s more guidance at the IRS's self-employed tax center, which links to info on calculating net profit and the types of expenses to include.

Net profit examples

Let's look at the numbers in action from two different types of businesses: a law firm and a clothing boutique.

Law firm

This firm earns $500,000 in revenue and, because it’s a service-based business, it has no cost of goods sold (COGS). That means its gross profit is also $500,000. From that, it deducts the following operating expenses:

• Wages: $200,000
• Office rent: $40,000
• Utilities: $6,000
• Taxes: $50,000

After subtracting all these costs, the law firm is left with a net profit of $204,000.

Since it doesn’t sell physical products, there’s no COGS to subtract. This is common for many service-based businesses. However, some—like landscapers or contractors—may still count materials as COGS.

Clothing boutique

This boutique also brings in $500,000 in revenue, but unlike the law firm, it sells physical goods. It spends $250,000 on inventory, which is recorded as its COGS. That leaves a gross profit of $250,000. From there, it subtracts:

• Wages: $40,000
• Rent: $40,000
• Utilities: $6,000
• Interest expense: $5,000
• Taxes: $21,000

After all expenses, the boutique ends up with a net profit of $138,000.

In this case, the COGS significantly reduces gross profit, and additional costs like interest expenses (from business loans) further impact the final net profit.

The thing to notice with these two net profit examples is that they have the same revenue ($500,000) but different net profits. That's because of the difference in expenses.

That also leads to different net profit margins. The law firm turned 40.7% of its $500,000 in revenue into profit, while the boutique’s profit from its $500,000 in revenue was only 26.7% of that.

Iowa State has more tips on calculating profits for your business.

Gross profit vs net profit

Again, gross profit is the difference between revenue and COGS. Net profit is one step further: gross profit minus operating expenses, interest, and taxes.

The formulas make this clear:

• Gross profit = revenue – COGS
• Net profit = Gross profit – operating expenses – interest and taxes - depreciation & amortization

To nail these concepts down, let's look again at the retail example above.

The boutique spent $250,000 on inventory. When you subtract that from revenue, there's a gross profit of $250,000. Then, when you subtract the rest of the expenses as well as tax and interest, you get a net profit of $138,000.

• The retail business's gross profit margin is 50% – after accounting for inventory costs, 50% of revenue is left over for operating expenses. To get a higher ratio, the business needs to figure out how to drop inventory costs.
• Its net profit ratio, as mentioned above, is 26.7%. To get this number up, the business needs to lower its operating costs.

UC Cincinnati has tips on how to do profit margin analysis for your business.

FAQs on net profit

How do I improve my net profit?

There are two ways to improve profits: reduce expenses or increase revenue. There are endless ways to pursue these goals: think about creating a new revenue stream, raising prices, a marketing campaign to get more customers, and improving efficiency to lower expenses.

Check out Xero's guide to increasing profits for more details.

What can cause my net profit to decrease?

Just as falling expenses and rising revenue improve profits, the opposite is also true: rising expenses and declining revenue decrease net profits.

Your job is to work out why your expenses are going up or your revenue is falling. The causes could be external, like an economic downturn or rising supplier costs, or internal factors like inefficient staff or outdated machinery. To decrease expenses, negotiate better terms with suppliers, buy in bulk, or figure out how to operate more efficiently. To increase revenue, consider doing more marketing to reach different types of customers, increasing prices, or adding new products or services.

Is net profit the same as taxable income?

No – while taxable income is the profit that is subject to tax, net profit is the profit left over after taxes have been paid from it. Taxable income includes revenue after you’ve taken out all expenses, interest, depreciation, and amortization.

Why do investors and lenders look at net profit?

Your net profit number is the number one indicator of your business’s financial health and creditworthiness. Investors and lenders will look at your net profit – and your profitability ratios in particular – to decide if your business is managing its costs and generating revenue reliably enough to be worth investing in or lending to. So if you’re looking for investment capital or loans to grow your business, you’ll need to show a record of profitability over time.

Net profit means success for your business

You’re in business to make a profit, right? A profitable business is a successful one – being profitable demonstrates you can manage your costs and increase revenue, generating the resources to reinvest in the business and reward its shareholders.

By regularly monitoring your profits as part of your business strategy, you can adjust your approach to respond to changing market conditions. Doing so can help boost profits by increasing revenue and helping you to manage your costs more efficiently.

Here are Xero’s thoughts on boosting your profits