Gross Profit vs Net Profit
What separates the two figures?
Gross profit is revenue minus what the goods cost you. Net profit is what is left after everything else. In between go rent, wages, insurance, marketing, depreciation, interest and tax, and that is a long list, so the two numbers usually end up far apart.
Both are profit and both are correct. Gross profit asks whether the product works. Net profit asks whether the business works. A shop can pass the first test easily and fail the second, and that particular combination is the most common shape of a business heading for trouble.
How do you get from one to the other?
A café on £300,000 of annual sales, walked down line by line.
| Line | Amount | Margin on revenue |
|---|---|---|
| Revenue, excluding VAT | £300,000 | 100% |
| Cost of goods sold | −£84,000 | 28% |
| Gross profit | £216,000 | 72% |
| Wages and employer costs | −£120,000 | 40% |
| Rent and business rates | −£36,000 | 12% |
| Utilities and insurance | −£22,000 | 7.3% |
| Equipment, repairs, depreciation | −£14,000 | 4.7% |
| Marketing, card fees, software | −£14,000 | 4.7% |
| Operating profit | £10,000 | 3.3% |
| Interest on fit-out loan | −£2,000 | 0.7% |
| Corporation tax | −£1,520 | 0.5% |
| Net profit | £6,480 | 2.2% |
Seventy-two percent at the top, a little over two at the bottom, and nothing unusual anywhere in between. Wages alone consume more than half the gross profit, which is ordinary in hospitality and why staffing decisions move the bottom line more than pricing does in that trade.
Which figure should you be using?
Whichever matches the decision in front of you.
Gross profit for pricing and buying
It reacts directly to what you pay suppliers and what you charge customers, and it reacts fast. Overheads only dilute the signal, so leave them out while you are deciding whether a line earns its shelf space. Our gross margin calculator and GP calculator cover this end.
Operating profit for comparing businesses
It includes the cost of actually running the operation and excludes financing and tax, which vary with ownership structure rather than trading performance. Our operating margin calculator handles it.
Net profit for valuation, lending and tax
The figure that reaches the balance sheet, and the one an outside party will judge you on. Our net profit margin calculator turns it into a percentage.
What does the gap between them tell you?
The distance from gross to net describes your cost base, and its shape is worth reading.
A wide gap on top of a high gross margin is normal in hospitality, salons, anything staff-heavy. The risk there is volume. Fixed costs are large, so a quiet quarter goes straight through the bottom line without touching the sides.
A narrow gap under a low gross margin is the wholesale and distribution pattern. Thin percentages, light overhead, and profitability that depends on turnover and on remembering to claim your supplier rebates.
The one to act on is a gap that widens over time. Overheads have grown faster than gross profit, and it almost never happens through a single decision. It happens through subscriptions nobody cancelled, an insurance renewal nobody queried, and one more person on the payroll. Comparing this year's percentages against last year's, line by line, finds it far quicker than staring at the totals.