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Key Takeaways
- Net income is total sales minus all expenses and taxes.
- Gross income is revenues minus the cost of goods sold.
- Gross profit evaluates product-specific performance.
- Net income is crucial for evaluating stock value.
- The bottom line represents net income on income statements.
Overview: Gross Profit vs. Operating Profit vs. Net Income
Gross profit, operating profit, and net income are reflected on a company’s income statement, and each metric represents profit at different parts of the production cycle and earnings process.
While income indicates a positive cash flow into a business, net income is a more complex calculation. Profit commonly refers to money left over after expenses are paid, but gross profit and operating profit depend on when specific income and expenses are counted. We break down the calculation and significance of each term so you can make more informed financial decisions.
Discover the distinctions and learn how each represents different stages of a company’s financial performance.
Net Income vs. Gross Income
Net income is the total sales of a company minus expenses like the cost of goods sold (COGS); selling, general, and administrative (SG&A) expenses; operating expenses; depreciation; interest; and taxes.
Gross income is the total revenues of a company minus the cost of goods sold (COGS). Businesses often use gross income instead of net income to better gauge their product-specific performance.
Exploring the Income Statement
All three financial metrics—gross profit, operating profit, and net income—are located on a company’s income statement, and the order in which they appear shows their significance and relationship.
The top line of the income statement reflects a company’s gross revenue, or the income generated by the sale of goods or services. Using the revenue figure, various expenses and alternate income streams are added and subtracted to arrive at different profit levels.
Gross Profit Explained: Revenue Minus Production Costs
Gross profit is the total revenue minus expenses directly related to the production of goods for sale, called the cost of goods sold (COGS). COGS represents direct labor, direct materials, or raw materials, and a portion of manufacturing overhead tied to the production facility.
Image by Sabrina Jiang © Investopedia 2021
COGS does not include indirect expenses, such as the cost of the corporate office. COGS directly impacts a company’s gross profit, which reflects the revenue left over to fund the business after accounting for the costs of production. Gross profit does not account for debt expenses, taxes, or other expenses required to run the company.
Operating Profit: Beyond Gross Earnings
Derived from gross profit, operating profit is the residual income after all costs have been included. Operating profit is also called operating income or earnings before interest and taxes (EBIT). But EBIT can differ from operating profit if it includes nonoperating revenue, which is not included in operating profit. If a company doesn’t have nonoperating revenue, then EBIT and operating profit will be the same.
In addition to COGS, fixed-cost expenses, such as rent and insurance, and variable expenses, such as shipping and freight, payroll and utilities, and amortization and depreciation of assets, are included. Operating profit does not account for the cost of interest payments on debts, tax expenses, or additional income from investments.
Image by Sabrina Jiang © Investopedia 2021
Net Income Decoded: The Ultimate Profit Indicator
A company’s profit is called net income or net profit. Since net income is the last line at the bottom of the income statement, it’s also called the bottom line. Net income reflects the total residual income after accounting for all cash flows, both positive and negative.
Using the operating profit figure, debt expenses such as loan interest, taxes, and one-time entries for unusual expenses such as equipment purchases are subtracted. All additional income from secondary operations or investments and one-time payments for things such as the sale of assets are added.
Important
Net income is the most important financial metric, reflecting a company’s ability to generate profit for owners and shareholders.
Why Does Net Income Matter to Investors and Businesses?
For business owners, net income can provide insight into how profitable their company is and what business expenses to cut back on. For investors looking to invest in a company, net income helps determine the value of a company’s stock.
What’s the Difference Between Operating Income, Operating Profit, and EBIT?
Operating income is a company’s gross income minus operating expenses and other business-related expenses, such as depreciation. The difference between operating income and earnings before interest and taxes (EBIT) is that EBIT includes nonoperating income, nonoperating expenses, and other income. EBIT is also known as operating profit, unless it includes nonoperating revenue.
Why Is Net Income Known as the Bottom Line?
The bottom line is a company’s net income and the last number on a company’s income statement. The bottom line is a company’s income after all expenses have been deducted from revenues.
The Bottom Line
Gross profit, operating profit, and net income are shown on a company’s income statement, and each metric represents profit at different points of the production cycle.
Gross profit represents revenue minus the cost of goods sold (COGS). Operating profit is derived from gross profit after subtracting operating expenses, excluding debt and tax costs. Net income represents the total earnings after considering all expenses, taxes, and additional income.
