Net income is a type of profit. It is typically known as the “bottom line” figure for small businesses on their income statement after all expenses are removed. Net profit, on the other hand, is slightly different because it is the pure profit that a business earns after deducting various classes of expenses. Net profit is used to calculate the firm’s tax liability on its revenue as well as business profitability.
The differences between net income and net profit are subtle, but they are important to understand as you develop your knowledge of a business’s financial statements.
What Is Net Income?
Net income is calculated on the income statement and shows what a business has earned after subtracting expenses such as operating expenses, cost of goods sold (COGS), depreciation, interest, and taxes along with allowable deductions during a specific accounting period. This period could be a month, a quarter, six months, or one year. Net income is considered the “bottom line” figure on the income statement.
How To Calculate Net Income
Net income is calculated by the equation:
Revenue - Expenses = Net Income
Net income is the total income from revenue (sales and other income) after all business expenses are deducted. Both the revenue and expense figures can be obtained from the business’s income statement.
Types of Business Expenses
The first, and arguably the most important business expense is COGS, which can be defined as the firm’s direct production costs like raw materials, labor, and overhead. If a business sells services instead of products, it does not have cost of goods sold.
After you report your total revenue from your business and COGS, you can then follow the traditional income statement format to report your business expenses.
It is crucial to keep good bookkeeping or accounting records year-round so you will be able to quickly summarize your business expenses.
Following the income statement format, here are some examples of business expenses you might incur:
- Selling and operating expenses: Examples are commissions paid to salespeople, advertising, contract labor, rent, insurance, repairs and maintenance, and travel and meals.
- General and administrative expenses: Examples are car and truck expenses, depreciation, interest on mortgages, lease expenses, legal and professional expenses, office expenses and supplies, taxes and licenses, and utilities.
- Other: Examples are any income the business receives that is not counted as a sale. Selling an asset for a profit would be an example.
- Interest expense: This is the interest the business has to pay if it has any outstanding debt.
- Income tax expense: This is the business’s tax liability based on profit.
The “foreign currency” line item on the income statement is usually not applicable for small businesses. You can look at IRS Form Schedule C to see these and other categories of business expenses.
What Is Net Profit?
The most obvious difference between net income and net profit is that net income is the “bottom line” of the firm’s income statement from which all expenses have been deducted. Net profit, however, indicates the profitability of the business for a specific time period.
Another difference is that net profit can be calculated in stages. For example, if you look at an income statement you will see that profitability, in dollars, is calculated after each section of expenses. The three components of profit on an income statement are gross profit, operating profit, and finally, net profit.
The calculations for each are as follows:
- Gross profit: Revenue - COGS
- Operating profit: Gross profit - operating expenses - depreciation - amortization
- Net profit: Total revenue - total expenses
Net Income vs. Net Profit
Here is a comparison table outlining the differences between net income and net profit:
|Comparison||Net Income||Net Profit|
|Definition||Net income is the bottom line number on the income after all expenses are deducted.||Net profit indicates the profitability of the firm. Expenses are deducted from revenue to arrive at a net profit for each type of expense.|
|What Does It Show?||It shows the total cash inflow of revenue minus expenses during an accounting period.||It shows the dollar profitability of the business..|
|Types||Earned and unearned||Gross profit or net profit|
|Dependency||Dependent on revenue and profit||Dependent on revenue only|
|Uses||Allows you to calculate total actual earnings and give investors the ability to assess revenue and expenses of your business.||Allows you to calculate the profitability and tax liability of the business for a particular time period.|
Both net profit and net income are important financial metrics and should be calculated each accounting period for the business firm.
Frequently Asked Questions (FAQs)
What is a good net profit?
There is really no magic number. A good net profit depends on the business itself and the industry in which the business operates. You can compare your net profit to the industry average net profit as a benchmark. Economic conditions can also impact net profit. In a general sense, we can say that a good net profit margin exceeds 10%.
What is the difference between gross profit and net profit?
Gross profit is what you have left on your income statement after you deduct COGS from revenue. Net profit is what you have left after you deduct all your expenses including operating expenses, depreciation, and amortization.
When would FIFO report higher gross profit and net income than LIFO?
FIFO will report higher gross profit and net income when the assumption is made that the products that make up COGS are lesser in value since they were purchased in the past.
IRS. "Profit and Loss From Business."
Accounting Tools. "Net Profit Margin Definition."