Gross Vs. Net Profit

The comparison, gross vs. net profit, is simple enough, as the two types of profits are principally steps to the calculation to the profit gained by a business or a venture in a said accounting period. Gross and net profits are just two accounting profits. However, before we go on to the difference between gross profit and net profit, let us have a look at some businesses conventions regarding derivation of profits in an accounting period.

Profit Derivation Conventions

Any establishment, which is engaged in any kind of economic or business activity, tends to calculate a profit at the end of an accounting year. This profit calculation can take place, on a daily, basis, weekly or on a monthly basis, quarterly basis (every three months), 6 month basis or on an annual basis. This frequency of calculation principally depends upon the working of the business organization.

Now there are two 'accounts' or financial statements that are prepared by the business organizations, the first one is the production or trading account, which signifies the incomes and expenditures that are directly related to the operation. For example, if a business manufacture's furniture, then salary of crafts men and wood purchased become the direct expenditures while the direct incomes would include the sale of finished furniture. The second statement includes the secondary or overhead costs, such as repair of power tools or cost of advertising or taxes. Indirect incomes would on the other hand include, the sale or scarp material or interest on bank balance. These two types of incomes and expenditures that is direct incomes and direct expenditures play a highly instrumental role in calculation of both the profits. The reason that these profits are calculated is that it gives the managers of the business a good overview of the performance and standing of the business and contributes in financial management.

Now one might argue that there are some incomes and expenditures that occur at a fixed rate only once a year, for example taxes. However, with the help of simple arithmetic division, this expenditure can be split into smaller sub subsets, such as taxes payable per week or month. With these two statements, or rather accounts, one can derive the net profit and gross profit. With the help of this accounting the cash flow of the business can also be derived.

Gross Profit Vs. Net Profit

As mentioned above, the first statement, manufacturing or trading account, is a record of direct incomes and expenditures. The gross profit is calculated deducting the expenditures from incomes.

Therefore,

Gross Profit = Direct Incomes - Direct Expenditures

In this case, direct incomes would include sales while direct expenditures would include, purchases of material and direct wages.

The second statement includes, the indirect overheads and indirect incomes, that is they are not direct participants to the production process. The net profit is calculated by deducting the expenditures from incomes and then adding the gross profit to the sum.

Thus,

Net Profit = Gross Profit + Indirect Incomes - Indirect Expenditures

Some related concepts which are calculated in the same manner, but in different situations include, gross vs. net revenue, where the gross is difference between the actual purchasing and selling price while indirect selling costs are deducted from it and incomes are added to get a net revenue. A similar concept is that of net sales vs. gross sales. Another similar one is gross vs. net pay.

The aforementioned was a bit informal and non-statuary bit of gross and net profit. The concluding point is that the gross profit is the difference between the direct incomes and expenditures, while on the other hand, the net profit is the difference between indirect expenditures and incomes plus the already derived gross profit.