Gross Profit vs. Operating Profit vs. Net Income: An Overview
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.
Key Takeaways
- Gross profit is total revenue minus the expenses directly related to the production of goods or the cost of goods sold (COGS).
- Derived from gross profit, operating profit is the residual income after accounting for all costs.
- Net income reflects the total residual income after accounting for all cash flows, both positive and negative.
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.
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Gross Profit
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.
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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
Derived from gross profit, operating profit is the residual income after all costs have been included. Operating profitis also called operating income or earnings before interest and tax (EBIT). EBIT can include non-operating revenue, which is not included in operating profit. If a company doesn't have non-operating revenue, 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.
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Net Income
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.
Net income is the most important financial metric, reflecting a company's ability to generate profit for owners and shareholders.
Why Is Net Income an Important Number for Investors and Businesses?
For business owners, net income can provide insight into how profitable their companyis 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 Is Operating Income vs. Operating Profit vs. EBIT?
Operating income is a company's gross income minus operating expenses and other business-related expenses, such as depreciation. The difference between EBIT and operating income is that EBIT includes non-operating income, non-operating expenses, and other income.
Why Is Net Income Called 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 isa 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 is total revenue minus the cost of goods sold (COGS). From gross profit, operating profit or operating income is the residual income after accounting for all expenses plus COGS. Net income is the bottom line, or the company's income after accounting for all cash flows, both positive and negative.
