Gross profit vs net profit: the difference, with one quarter's P&L worked through

Gross profit vs net profit comes down to how much has been taken off revenue. Gross profit is revenue minus the cost of goods sold, before any overhead; net profit, or net income, is what is left after operating expenses, depreciation, interest and income tax as well. On a quarter with $6,000,000 of revenue, gross profit is $1,800,000 (30.0%) and net profit is $292,500 (4.9%).

The difference in one table

The SEC's Beginners' Guide to Financial Statements describes the same staircase: costs of sales come off net revenues to give gross profit, which is "considered 'gross' because there are certain expenses that haven't been deducted from it yet." Operating expenses and depreciation come next, and at the bottom is what the company actually earned or lost. For the wider ladder from the top line down, see revenue vs profit.

The formulas

Gross profit = Revenue − Cost of goods sold

Gross margin = Gross profit / Revenue

Net profit = Gross profit − Operating expenses − Depreciation and amortization − Interest − Income tax

Net margin = Net profit / Revenue

Both margins divide by the same revenue, so they can sit side by side in one row. SEC filers present the captions in this order under Regulation S-X Rule 5-03: costs and expenses applicable to sales, then selling, general and administrative expenses, then "income or loss before income tax expense", income tax expense, and finally "net income or loss".

One quarter from revenue to net profit

One company, one quarter. Tax is 25% of income before taxes: the 21% federal corporate rate (the Form 1120 instructions tell corporations to multiply taxable income "by 21% (0.21)") plus an assumed blended state rate, and taxable income is taken as equal to book income to keep the example simple.

The two margins, with revenue in B2:

Gross margin:  =B4/B2    returns 30.0%
Net margin:    =B10/B2   returns 4.9% (4.875%)

The check is the bridge from gross to net, one line at a time, and it must land on the net profit row:

1,800,000 − 1,260,000 − 90,000 − 60,000 − 97,500 = 292,500. If the bridge and the P&L disagree, a cost has been left out or counted twice. A bridge built this way is also how you explain a change between two periods.

Gross profit vs gross margin

Gross profit is an amount in dollars: $1,800,000. Gross margin is that amount as a share of revenue: 30.0%. Both are reported because they answer different questions. The amount says how much there is to pay for overhead, financing and tax; the percentage says how much of each sales dollar is left, and it is the one you can compare across quarters, product lines or companies of different sizes. The full method, including why a group margin is never the average of line margins, is on the gross profit margin page.

Which one answers which question

Gross profit is the measure for pricing and buying: list price, discounts, supplier costs and product mix. If it falls, look at realized prices and unit costs.

Net profit is the measure for the whole business: overhead, the cost of the balance sheet and tax. If gross profit holds and net profit falls, the answer is below the gross line.

Between the two sit the levels that make the gap readable. Gross margin vs contribution margin vs net margin takes the same ladder down to each customer, with the costs to serve them in between.

Why gross profit can rise while net profit falls

In quarter 2, revenue grows 5% and cost of goods sold grows 5%, so gross margin stays at 30.0%. Operating expenses rise 12%.

Gross profit rose $90,000; operating expenses rose $151,200. Income before taxes fell by the difference, $61,200, and tax took a quarter of the fall, so net profit dropped $45,900, or 15.7%. A gross profit report alone would have called this a good quarter.

Where it goes wrong

• Gross profit on gross sales. Revenue must be net of returns, rebates and credit memos first; credit notes and returns booked a month later still belong against the original sales.
• Delivery costs that change lines. Freight to customers in cost of goods sold one quarter and in operating expenses the next moves gross margin with no change in trading.
• Profit and margin used interchangeably. "Gross profit fell 2" means nothing until you know whether that is $2 million or two points.
• Net profit growth read without the tax charge. A lower effective tax rate or a one-time gain can lift net profit while operations get worse. Check income before taxes and the one-off lines first.
• Customers judged on gross profit alone. A customer with a good gross margin can still lose money once its delivery, service and credit costs are counted.

By customer, not only for the company

The company-level bridge says that net profit fell; it does not say which customers, products or cost lines did it. Covirage's tools compute gross profit and the costs below it from your ledger export and build the bridge line by line, reconciled to the P&L; the external AI model explains the movement using those figures and does none of the arithmetic. See customer profitability for gross and contribution margin per customer, and margin by account for the method. For net profit as a share of revenue, see net profit margin.