Gross profit vs net profit – understanding why both are important for small business owners
Knowing what your gross profit and net profit are is a fundamental part of running a business. In the simplest terms:
Gross profit – you calculate what your gross profit is by taking your total turnover, minus the costs of the goods sold.
Net profit – this is what’s also known as your bottom line. It’s what’s left after you’ve deducted all your costs from your total turnover, i.e. the costs to you of the goods as well as all your business overheads, staff costs, interest on any business loans etc.
How to use gross profit to help you increase net profit
If you are taking steps to increase turnover, it will obviously have a knock-on effect on your net profit – ideally a very positive one.
You may want to offer discounts in order to get more business – “pile them high and sell them cheap” as the idiom goes. If your overheads stay the same, this is all well and good, but if your strategy to sell discounted products is successful, you may well need to increase your overheads in order to cope with the extra demand, and this will impact your net profit.
As soon as you understand your gross profit margin, you can use it to calculate whether any extra overhead costs involved in getting those extra sales are a justifiable business expense.
We find that, as a general rule of thumb, if you are looking after your overheads properly, the net profit should take care of itself. There’s a great phrase, “turnover is vanity, profit is sanity but cash is reality”, which means you need to get your profit right before taking care of your working capital.
If your small business is based in Hertfordshire and you would like to know more about our services and find out how our local Hertfordshire Accountants can help your business succeed, contact us to book an appointment.