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The world of finance is filled with numerous terms, and each one has a very specific definition.
It might seem at times that some are close in terms of definition. However, a company’s financial health requires several different words, just like a painting generally requires several different colors.
In this article, we’ll help you understand the difference between gross profit and net income. “Profit” and “income” might seem like the same ideas.
However, that’s a bit like saying every blue is the same when there are literally hundreds of defined shades of blue.
Let’s get right to it so you can start to better understand more about what the financial statements are telling the markets.
What is Gross Profit?
“Gross Profit” is the profit a company generates after the costs of producing goods and services are deducted from net sales.
The costs of production are typically called Costs of Goods Sold (COGS). Here is the simple equation to help illustrate the term:
Gross Profit = Net sales – COGS
Indeed, more definitions are involved in this. Let’s dig into each one to better understand gross profit, starting with “net sales.”
“Net sales” is the total amount of money a company makes from the sales of goods or services, including discounts and returns.
“Costs of Goods Sold,” or COGS represents the money spent directly on producing the goods or services which are later sold to generate revenues. It excludes expenses for things like overhead and marketing.
The COGS figure can be quite complicated and generally has the most room for error. Hence, accounting standards are in place to help define how it is calculated on a financial statement.
When reviewing a company’s income statement, the gross profit can be found close to the top of the reported figures directly underneath sales revenues and COGS.
It’s worth noting that some companies will use different words on their statements, such as “net sales” instead of “gross profits” and “costs of sales” instead of “COGS.”
For instance, Apple’s 2020 financial statement, also called the Form 10-K, reports Total Net Sales of $274.515 billion at the very top of the “Consolidated Statements of Operations.”
Below this is a section headed by “Cost of sales.” The total cost of sales for 2020 was $169.559 billion. This is the same as the COGS.
Subtracting the Total Net Sales from the Total Cost of Sales gives the Gross Margin of $104.956 billion, which is Apple’s gross profit for 2020.
When reviewing the financial statement, you may need to use context clues to help you get your bearings.
By understanding the Gross Profit equation, you can generally find it by looking at a statement and making a few educated assumptions about what the terms are trying to tell you.
What is Net Income?
“Net income” is a broader term than gross profit because it represents the total net profit the company generates.
More specifically, net income is the total revenue from all sources, less all expenses and costs necessary for the company to generate profits.
Here is the equation:
Net Income = Total Revenue – Total Operating Expenses
A company’s total revenue includes the sales of products and income from the sale of real estate or other property, interest on cash and other accounts and investments, etc.
Total operating expenses are different from COGS because they include all expenses not directly related to producing goods or services.
Taxes, all employee wages and benefits, depreciation of assets, marketing, and other expense categories fall into this category.
A company’s net income can usually be found on the same page as the gross profit. Underneath the gross profit section will usually be the operating expenses, followed by taxes and other information.
As the top-level overview of the company’s financial performance, several of the figures are detailed later in other sections of the report, though all expenses are captured before providing the company’s net income or net profit.
Continuing with the example using Apple’s 2020 financial statement, remember that Apple’s gross profit was $104.956 billion.
The Total Operating Expenses were $36.668 billion, an additional income of $803 million was added, followed by an estimated $9.68 billion deduction for income taxes.
This results in Apple’s 2020 Net Income of $57.411 billion.
What Is the Difference Between Gross Profit and Net Income?
Gross profit and net income can both be phrased differently, so it’s important to understand the purpose of each term so you can more easily understand what the financial statement is telling you.
Let’s start with another quick summary of what each one is.
- Gross profit is the profits from selling products or services less the costs directly associated with producing those goods or services.
- Net income is also a type of profit, but it represents the total net profit of a company, meaning profit, after all, operating expenses and taxes company-wise are deducted.
It’s important to highlight that gross profit refers only to profits from sales of whatever the company produces.
This does not include other forms of income like real estate, interest, or investment income.
One deviation from this rule is that real estate companies would naturally report income from a real estate sale since that is where the company profits are generated.
On the other hand, net income is all income for the company. All expenses are reduced, representing the total picture of how much profit the company generated.
Both can be used to paint a different picture of the company, so they are both critical figures on the financial statement.
While the total net profits are obviously important to help show investors how the company is overall, it’s possible too much money is being spent on actually generating those profits.
This is where analysts on Wall Street would look at gross profit.
It specifically helps the company and Wall Street understand how efficient the company is with expenses related to producing their goods or services.
Gross Profit vs. Net Income Example
Just to reinforce the Apple example, here is the 2020 financial statement illustrating where these figures are.
In Apple’s case, they even include the same numbers for the previous two years to find a short-term trend.
From Apple Inc., 2020 Form 10-K
Bottom Line: Gross Profit vs. Net Income
With all of the terms related to financial statements, it’s understandable that some of the terms can be confused.
This is especially true for gross profit and net income because, after all, they are both a type of profit.
However, accountants found out long ago that using the same or similar words helps everyone stay on the same page, so understanding the accounting language will help you better understand how a company is performing.