What is Net Profit and Why Is It Important?

Sales are an indicator of the success of your business. There is a more important measurement to look at, however – net profit. What is net profit, though?

What is Net Profit?

Net profit is the amount of money that is left after you subtract your total business expenses from your total revenue. In other words, it is a calculation that includes almost all financial transactions in your business.

The notable exception is tax – net profit does not include tax payments as tax calculations are based on a percentage of your net profits, i.e. the net profit figure is required before the tax calculation can be done.

The net profit calculation is:

  • Total Revenue – Total Business Expenses = Net Profit

Let’s break those items down a bit further:

  • Total revenue – this is your total sales minus refunds and sales discounts.
  • Total business expenses – this includes the cost of goods sold which is all expenses used to get the product to the customer. This includes the cost of materials, direct manufacturing costs, wholesale purchase costs for retailers, delivery costs, and more. Total business expenses also include business operating expenses and all overheads such as salaries, rent, loan interest, insurance, and more.

Why is Net Profit Important to You?

You should know and care about net profit as it demonstrates the success of your business. In fact, it is a far more significant figure than revenues as there is no point making lots of sales that ultimately don’t generate a profit.

Net profit also gives you an indication of the money you have available to pay to the owners and/or invest back into the business.

Other Reasons Why Net Profit Is Important

These are not the only reasons why net profit is important as other groups also have an interest in the net profit of your business. This includes:

  • The Revenue – to calculate the amount of tax you must pay
  • Banks and other creditors – banks and other organisations that loan to businesses use the net profit figure to get a better understanding of the business and to assess the suitability of the loan. In particular, the net profit will give them an indication of your ability to pay.
  • Competitors – if you are a limited company, your competitors will be able to access your net profit by analysing the return you submit to the tax authorities. This will give them a better understanding of your business and how successful it is.
  • Investors and shareholders – net profit is crucial if you are seeking investment in your business, or if you have shareholders. A healthy and consistent net profit figure will give investors the confidence they will get a return.

How to Improve Net Profit

  • Reduce overheads – reducing overheads can give you a one-off or an ongoing reduction in costs, depending on the overhead. Examples include saving on your telephone bills, travel expenses, staff salaries, and more.
  • Reduce the cost of goods sold – this includes things like negotiating better prices with suppliers, making the manufacturing process more efficient, outsourcing, and more.
  • Increase sales volumes – to spread costs in your business as far as possible.

Another effective method of improving net profit in your business is to get advice. This includes professional accountancy advice. To speak to a member of the Gilroy Gannon team, please contact us today.

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