When it comes to the world of accounting and finance, various terms are bound to come into play that can complicate matters even more. Despite the fact that different people on a regular basis use terms like net profit and net income interchangeably, they have a very specific definition. They can imply and mean very different things when used in the accounting scenario.
Any person starting out a business or managing their own finances must understand every aspect of both of these terms. If you are one of those people who are looking to understand these terms in the simplest way possible, then you have landed at the right page. In this blog, we will discuss everything about net profit vs net income. Without further delays, let us dive right into it!
Net Profit vs Net Income
Time and again, these two terms are used interchangeably, so much so that little to no difference is considered between them when it comes to day to day life. This is why to have a better understanding of their difference, it is better to first understand what they mean and how they are calculated.
What is Net Profit?
It is defined by the amount that remains after taking out all the operation expenses, interest rates, and other applicable taxes. In order to calculate the total net profit of a business, it is important to know the value of gross profit for that organization. Here is a formula to calculate the net profit.
Net Profit (NP) = Gross Profit – Expenses
*Note: The easiest way to determine whether your business is successful or not is by looking at the value of gross profit i.e. if it is positive then it means that the business is going the right direction and profits are generated or will generate soon enough.
Net Profit vs Gross Profit
Both gross and net profit play a vital role in the world of business. Even though both terms end with the same word i.e. profit, they mean two completely different things. To better understand the meaning of net profit, we must look at what gross profit stands for.
Gross profit is the amount that is left behind after taking out the costs for manufacturing and selling its products and services. Here is a simple formula to make things simpler:
Gross Profit (GP) = Total Sales – Cost of Sold Goods
*Note: Selling of any fixed assets should not be considered as a part of Total Sales. Rather, the selling of running goods needs to be kept in mind only.
Differences Between Gross Profit and Net Profit
The difference between gross profit and net profit is straightforward: Gross profit business owners understand how well they utilized their resources such as manpower, machinery, and other utilities in terms of finances. On the other hand, the net profit helps you understand the profitability of your business. It shows whether or not your business is a success in terms of finances and whether you are making more than you are spending on the business or not. If both of these terms are calculated properly and accurately, you can easily generate your income statement.
Gross profit provides you a number to work with to create revenue. It shows the total cost of your business that is required in order to start earning more money than the required amount for business expenditure. To put it into simpler words, if the cost of sold goods or services increases in your business, this means that you will have less revenue and vice versa. Through this number, you can understand how to minimize the cost of manufacturing goods thereby increasing revenues even more. Expenses can be reduced and better processes are implemented through this way.
The figure of your net profit represents the overall financial health of your business. It comes into handy when bank loans are required by businesses. A healthy and positive net profit usually creates a positive impact on the overall chances of a business getting loans from banks. Through this number, investors understand whether you would be able to pay your loans off in the future or not.
What is Net Income?
Apart from revenue, net income is the most important amount that is required to understand the performance of a business. The formula to calculate the value is:
Net Income = Total Revenue – Total Expenses
Net Profit v/s Net Income: The Key Differences
Essentially, both net income and net profit mean the same thing. Even if you look at both their formulae closely, you will come to realize that both are calculated by utilizing the same parameters. There is another term known as net earnings that is also used interchangeably with these two terms. Does that mean that they are different from one another? Not at all. Rather, they all point towards the same thing:
Net Profit, Net Income and even Net Earnings represent the remaining amount of money after taking out all the costs of manufacturing, expenses, and taxes in all forms.
Net Income vs Net Sales
Now that the basic confusion between net profit vs net income is behind us let us take a look at the difference between net income and sales. To put it in simple words, net income and sales are two different things. Here is how:
The net sales define the total sales of the company, which does not include the tax returns, allowances, and any discounts provided to the customers. The direct cost of an organization is determined by the net sales. Here is a formula representing how to calculate net sales:
Net Sales = Total Gross Sales – Sale Returns – Allowances – Discounts
As indicated by the formula, there are many terms impacting the value of Net Sales. This is why it is important to understand them before calculating and comprehending the role of net sales.
Any sale that has been completed without any discounts, allowances, or price reductions is known as gross sales. The mode of transaction i.e. debit card, credit card, or cash does not create a difference in this scenario.
Organizations that offer their customers the option of returning their goods have to consider this factor as well. Any goods that are bought, but then returned for whatever reasons, fall into this category. The refunds made to the customers from such sales are viewed as sale returns.
Many times, some products are damaged due to unforeseen circumstances. The company often reduces their total cost and gives it off to the customer at a lower rate than the rest of the intact product. Here is a formula to calculate this number easily:
Allowances = Marked Price – Selling Price
Any discount or price reductions offered to customers over a period of time also helps in determining the net sales value. These discounts can be in any form i.e. bulk purchases, seasonal sales etc.
Difference between Net Sales and Net Income
As explained above, both of these terms are different from one another and cannot be used interchangeably. One (Net Sales) implies the total amount earned from sales without factoring in taxes, resources/operations costs, and personnel expenses, while the other one implies the total amount earned from sales after subtracting taxes, resources/operations costs, and personnel expenses. Net income is more or less dependent on net sales as it helps in determining it.
Here is what you must remember: the investors, banks, and stakeholders understand the performance of your business by analyzing both of these amounts. Both these values are a part of the income statement.
Net Income vs Net Revenue
Net income and net revenue are also confused as the same thing sometimes (even though they are not). This is why it is important to understand what net revenue stands for.
As the name implies, this is the amount of money left after taking out the costs, losses, taxes, etc. from your total revenue. Here is the basic formula to calculate it:
Net Revenue = Gross Revenue – Sale Returns – Allowances – Discounts
Here Gross Revenue defines the total revenue that is generated without any deduction initially. No costs are subtracted from the revenue number generated in any form.
Difference between Net Revenue and Net Income
Net income is the total amount of earnings that are made by a company in a specific period. Net revenue is the amount earned by the company after selling goods or services through their day-to-day operations.
Net Income vs Net Profit: How They Affect Your Business
Net income or net profit is the most important factor when it comes to creating an impact on your business. A business owner despite having no background in the accounting world must have an expertise of these terms and values. Here is why:
- All these values help in determining the different ratios of the business performance. Decisions can be made by understanding these figures and looking at the overall numbers. Business owners get a clear picture about how well or poorly their business is performing.
- Stakeholders and bankers have a special interest in these values. By keeping them in a positive and reasonable range, they take decisions to give you funds or withhold them.
- Once you have collected data for several years, you can look at all these values in the form of charts and graphs. This can help you identify patterns as well as improve your financial performance over the years.
Due to all these reasons, it is essential to calculate them properly and keep an eye on these values throughout the fiscal year.
Best Accounting Software (Calculating Net Income vs Net Profit)
If you have no accounting background and are worried about your finances, then you really need to look into the different accounting software available. They are extremely helpful in calculating the net income and net profit values within seconds. Here is a list of three best accounting software that you must consider:
If you ever searched for an accounting software, it is more than likely that the name of QuickBooks will appear. There is an online version available as well. It is simple to use and there is a large number of resources related to QuickBooks so if you are a newbie then you can easily use it. It is a cloud-based app, available on mobile phones as well as desktops.
There are three different forms of payment plans available for users to choose from. You can add receipts and their pictures on the go. Many other features are also present in this software to make your accounting tasks easier. If you want to transfer data from one place to another, QuickBooks can present a bit of a challenge. However, other than that, there are numerous benefits attached with this software.
The interface of this accounting software is very easy to use. Any third-party payroll services are included in the software. You can also collect online payments after the integration of Strip or GoCardless. The inventory management is simple and easy to update. Xero also offers three different packages for their users to choose from. It is also a cloud based application which offers a mobile app as well.
The only drawback of this software is that it has a limited reporting option, which can become a hassle if you are looking for every minute detail. Nevertheless, a small business rarely concerns itself over such trivial matters hence it can be overlooked easily.
If you are a freelancer looking for a software to manage your accounts, Wave is the perfect solution for your services. You can easily turn off the option of payroll and inventory tracking, and simply send out different invoices. It allows you to add unlimited users to the app and there is no defined limit to the transactions being made.
Wave lacks in providing third-party app integrations. Moreover, the inventory management is little to none which makes it difficult to handle on a larger scale.
Understanding net profit vs net income is one of the most essential terms in the world of accounting. By having a clear idea of these terms, business owners are able to understand the financial conditions of their businesses. To reduce complications and mistakes, it is best to utilize the services of an accounting software. This is because a simple mistake in net profit or net income can make you lose a large number of funds or loans.
There are a large number of FAQs when it comes to the world of accounting. Here are answers to a few of them:
Q1. How does an accounting software help a business?
Most accounting software allow the users to synchronize their bank and credit card details with the software. This way the manual entry of data is not required. Moreover, the software provides all accounts receivable, accounts payable, and invoicing. Balance sheets, profit and loss statements, and cash flow are also presented through the software.
Q2. What are the three components of Net Profit/Net Income?
The three components of net profit/net income are gross profit, operating profit, and net profit.
Q3. Where is the net income situated in the income statement?
Net income can easily be found at the bottom of the company’s income statement.
Q4. Which value is the most important one for investors?
The net profit/net income is the most important value that all stakeholders and investors are interested in.
Q5. What does it mean when net income drops?
A drop in net income indicates that there is an overall decrease in the total amount left over in a certain time after taking out the amounts for expenses from total revenues.
Q6. Is net revenue the same as net income?
No, net revenue and net income are not the same thing as explained above. Net income is the total amount of earnings that are made by a company in a specific period. While net revenue is the amount earned by the company after selling goods or services through their day-to-day operations.