What is Net Profit?
This calculation represents the money leftover after expenses and taxes are paid. It is also commonly referred to as net income, net earnings, and "the bottom line." Read on to learn how to calculate net profit.
Why is Net Profit Important?
Net profit can give you a quick idea of the success of a company. This information is valuable to potential investors, managers, and stockholders. Obviously, the bigger the net income, the better it is for the business. However, just having a high net income one month doesn't necessarily indicate stable growth in the future. The goal is to create a consistent net income month after month. This is a sign that the business is expanding at a sustainable pace and can be expected to grow in the future. That is why investors generally look at the accounting figures over a one year period. That data is broken down into quarters to make comparison easier.
If your company is earning a large gross profit, but your net income isn't very impressive, it's time to analyze your expenses, taxes, and interest. First, you may lower expenses by finding ways to cut manufacturing costs. This could include using more affordable parts, but it can also include spending less money on your facility and equipment. When it comes to taxes, the IRS gets to choose that number. There are, however, some proper accounting techniques that allow you to write off certain expenses. Some corporations lower their taxes by making charitable donations. Lastly, the interest expenses can be lowered. This includes interest paid on loans. Some creditors will offer a discount for prompt or early payment, which can free up a lot of extra cash throughout the year. Carefully watching these costs, cutting back where possible, will help you improve your net income.
Factors of the Formula
The first part of the equation is gross profit. This tells us how much money remains after paying for the inventory that was sold. Thus, gross profit is equal to revenue minus the cost of goods sold. The next part is operating expenses, which is the amount of money spent on selling the inventory. This amount is subtracted from gross profit. Finally, we subtract taxes and interest from the gross profit to give us our net income. The interest used in this calculation is interest on loans.
Once you know the net income, you can also calculate the net profit margin, which shows the percentage of your revenue that is left after expenses are paid. Raising your net income will raise your profit margin.
How to Calculate Net Income
Let's look at a quick example:
Bayside Manufacturing Corp. has $450,000 in revenue, and $50,000 as their cost of goods sold. This leaves them with a gross profit of $400,000. They have $25,000 in operating expenses, $10,000 in taxes, and $5,000 in loan interest. Those three figures total $40,000. We subtract those costs from $400,000, which leaves us with a net income of $360,000. You can verify this by plugging these numbers into the net income calculator above.
Net Incomes at Large Corporations
To give you an idea of what kind of money big companies are working with, here are a few examples.
Coca Cola: $8.5 billion
PepsiCo: $6.7 billion
Hewlett Packard: $5 billion
IBM: $16.4 billion
Walmart: $16 billion
If a corporation's net income is $5 billion, that means they've earned even more money in sales. The figures above show the amount left after taxes, interest, and operating expenses are accounted for.