Net profit, also known as net income, is the ultimate earnings on a business after all fixed expenses and costs of goods sold are accounted for. You also include irregular revenue and expenses in your calculations. While companies need to monitor gross profit and operating profit to drive net profit, bottom-line income is integral to a business's sustainability and success.
Calculating Gross and Operating Profit
The process of calculating net profit includes calculations of gross profit and operating profit. In fact, each of these three profit levels is typically displayed on a company's periodic income statement. Gross profit is your revenue minus cost of goods sold in a period. If you earned $700,000 in revenue and had $350,000 in COGS, for example, your gross profit is $700,000 minus $350,000, or $350,000.
After you calculate gross profit, you subtract operating expenses to derive operating profit. Operating profit equals income generated from core business activities. Whereas COGS involved costs directly tied to each unit sale, operating costs are fixed and not based on volume. Utility expenses, marketing and building payments are common examples. If you had $200,000 in fixed overhead on your $350,000 in gross profit, your operating profit for the period was $150,000.
Calculating Net Profit
Certain sources of revenue and expenses a company incurs during a given period aren't related to primary business activities. Irregular revenue includes asset or investment sales, for instance. Irregular costs include facility closing costs and legal costs. While these don't impact operating profit, they do affect the bottom line. You can go from an operating profit to a net less with high irregular expenses, or from an operating loss to a net profit with high irregular revenue.
If you had $50,000 in irregular revenue and $100,000 in irregular expenses during the period in which you earned $150,000 in operating profit, your net profit was $100,000. You get this figure by subtracting $100,000 in irregular expenses from $50,000 in irregular revenue, which is a net loss of $50,000. You then subtract that from the operating profit of $150,000 to arrive at $100,000.
Managing Net Profit
Companies don't always generate net profit. Some operate at a loss due to poor performance or unfavorable economic conditions. Others lose money during the early stages of growth and development, when it is common to incur high startup and marketing costs to build a brand and customer base. At some point, however, owners, creditors and investors want to see a net profit. This shows them that the business is operating efficiently and successfully. When a business consistently produces net losses, managers must look for new revenue streams and ways to trim fixed expenses and COGS.