Financial success is the goal of every business owner. Keeping track of your profits is a smart financial habit that helps you gauge the financial health of your organization. Some business owners use the terms net income and profit interchangeably, but there's actually an important difference between the two.
A thorough understanding of these two terms and the differences between them is essential to effectively communicate a company's financial performance. We'll go into more detail about net income and profits to help companies better understand these important financial metrics.
What is Net Profit?
Net income, also known as net profit or net income, is equal to the sum of total income after deducting expenses. Net income is derived from various calculations, including total income, expenses, and sources of income for a particular period. Other sources of income include sales of company assets, depreciation of assets, lump sums for special events, and business taxes. Expenses may include costs associated with manufacturing products or interest on business loans.
Because net income is calculated after expenses are deducted, it is considered a good indicator of a company's financial health. To ensure the accuracy of net income, income and expenses must be tracked on an ongoing basis. Over time, net income from each year can be compared to determine whether a company has grown as expected or remained stagnant.
Analysts and potential investors in your company will often consider the specific calculations used to determine your company's taxable income in addition to your total net income, because net income figures can be manipulated by concealing expenses or other unethical practices.
Common examples of expense fraud include fictitious purchases, inflated reports, and inflated expenses submitted for reimbursement.
What is profit?
Profit is the financial benefit a business receives after deducting expenses, taxes, and other related costs. To calculate profit, subtract total expenses from revenue. Profit is an important indicator to business managers of how their business is performing.
If a business has income, it has profits. However, breaking down profits into categories can help you calculate the true financial position of your business.
There are three types of benefits:
You list each profit type on your company's income statement to let stakeholders know how your company's overall performance is. Here we'll take a closer look at how each profit type is calculated and why these numbers are important.
gross profit
Gross profit or gross revenue is the total income from sales after deducting all costs associated with producing and selling the goods. For service-based businesses, this is the profit after deducting the costs associated with providing the service.
Total gross profit is useful when looking at variable costs within a business. Variable costs are costs that change based on the level of output. Gross profit does not include fixed costs such as manpower or equipment.
Here are some examples of variable business costs:
Generally, the first line item on an income statement is total sales, followed by cost of goods sold. The formula for gross profit is:
Total Sales – Cost of Goods Sold = Gross Profit
Net income
The income that remains after deducting all expenses, including taxes and interest, is called net income or net revenue. Managers and stakeholders often rely on net income figures to get the most accurate picture of a company's financial health.
However, net income figures can be misleading: while net income tells you how much cash a company generates, profitability also depends on how that cash is invested.
The formula used to determine a company's net profit is:
Operating Profit – Taxes and Interest = Net Profit
Operating income
Before you can determine your net profit, you need to calculate your operating profit, which is the amount left over after subtracting your operating expenses from your gross profit.
Unlike gross profit, operating profit includes both fixed and variable costs. A business's operating expenses may include administrative costs and expenses related to general business needs.
Operating profit is often referred to as “EBITDA,” which means “earnings before interest, taxes, depreciation and amortization.” To calculate operating profit, use the following formula:
Gross Profit – Operating Expenses = Operating Profit
Small business benefits
In the small business world, profits are considered direct income. If your income statement shows higher expenses than profits, this is the first indicator of a financial loss.
To get the most accurate picture of a company's financial health, take the time to analyze all three types of profit. This analysis is done through profit margins, which are the ratio of an organization's profit divided by revenue. Profit margins can provide insight into how well a company is managing its income.
Net Income and Profit Examples
While profit can be used as a general reference for several different figures, net profit is a specific type of profit.
For example, let's say Company Z lists its gross profit as $100,000 for 2023. This figure equals revenue minus cost of goods sold.
However, Company Z reports net income of $45,000. This total is what's left over after deducting operating expenses and taxes from the company's gross profits.
Net income is always expected to be lower than gross income.
Best accounting software for tracking net income and profits
The best way to consistently and accurately track a company's net income and profits is with accounting software. While most software providers offer the ability to track totals, business owners should evaluate the reporting features of their accounting solution.
We've compiled a list of the best accounting software, but which provider you choose will ultimately depend on what's most important to your business. Learn more in our accounting tips for small businesses.
Quickbooks Online
QuickBooks Online is one of the most popular accounting software solutions and tops our list as a great choice for growing businesses. The software has been around for nearly 20 years and has the features to support almost any business type.
Key features of QuickBooks Online include:
- Automatic Bank Feed: QuickBooks comes with an automated bank feed to help you keep track of your transactions.
- Direct billing: QuickBooks includes a Gmail app feature for sending invoices directly from email.
- Live Bookkeeping Services: Live bookkeeping services are available for a monthly fee based on a $500 fee plus average expenses.
- Inventory features: Depending on the plan you choose, QuickBooks also offers inventory management. You can add inventory images, track your inventory through the software, and bundle items that are often sold together. This feature is especially useful for businesses that manage large amounts of inventory.
To learn more, read our in-depth QuickBooks Online review.
zero
If you run a project-based business, you should consider Xero as your accounting software choice.
Some of Xero's features include:
- Recurring invoices
- Integrates with 1,000+ business apps
- Inventory Tracking and Purchasing
The software also offers a smart bank reconciliation tool that makes it easy to reconcile transactions. Reporting is easy, with the option to run detailed financial reports such as profit and loss statements and balance sheets. Xero comes with a mobile app that helps you consistently track your account activity, claim mileage, and keep track of billable hours.
To find out more features, read our in-depth Xero review.
Zoho Books
If you run a very small business with fewer than 10 employees, consider Zoho Books for your accounting needs. Zoho Books offers inventory tracking and project management, and is more affordable than most software providers. Although it's perfect for very small businesses, Zoho Books can scale to fit growing businesses and organizations of any size.
Here are some of our favorite features:
- Convert quotes and orders into invoices
- Schedule an invoice for later
- Send invoice by mail
- Compatible with payment processors like PayPal, Braintree, Stripe, Square, and more [See our picks for best credit card processors for more information]
To find out more, read our in-depth Zoho Books review.
Fresh Books
If you run a service business, such as a marketing company, consulting firm, or law firm, consider FreshBooks as your accounting software solution. FreshBooks excels at creating professional invoices, scheduling payment reminders, and offering easy online payment options. It also lets you track billable time and manage projects.
Here are some of our favorite features:
- Free 30-day trial
- Customized Branded Invoices
- Ability to track billable hours
- User permissions to prevent fraud
Read our full FreshBooks review to learn more.
Proto
One of the keys to making a profit is collecting accounts payable. Plooto makes this easy. Not only can you create invoices, but you can also automatically send invoices and handle payment processing. To take advantage of early payment discounts offered by vendors, you can set up Plooto to automatically approve and pay vendors.
Some of the best features are listed below:
- Accounts Payable Automation with Vendor Networks
- Optional credit card processing built in
- Payment Tracking
Read our full Plooto review to find out more.
Avoid the temptation to manually process financial data
Regardless of the size or industry of your business, accounting software is one of the best tools for tracking profitability. It may be tempting to process your financial data manually, especially if you run a small business. However, human error is inevitable, so it helps to have an automated process in place before your business scales up. Evaluating different types of profits can be complicated, and the best way to make the analysis as easy as possible is to use a good software.
Jennifer Dubrino contributed to this article.
