What is Net Profit? Importance, Formula and Example

Net profit is a key number that shows how much money a business really makes after paying all its bills and expenses. It’s like checking how much cash you have left after covering everything you owe. This article will explain what net profit is, why it’s important, how to calculate it, and what net profit margin means.

What is Net Profit?

Net profit is the money a business has left after subtracting all its costs from the money it earned. These costs include things like the price of goods, rent, salaries, taxes, and loan interest. Net profit is also called Profit After Tax (PAT) because it’s what remains after paying taxes to the government.

Net profit is important because it shows if a business is healthy. A good net profit means the company is earning more than it spends. If the net profit is low or negative (meaning the business spent more than it earned), it’s a sign that something needs to change.

Example: If a company earns ₹20,00,000 from sales but spends ₹15,00,000 on goods, rent, and other expenses, the net profit is ₹5,00,000. This is the actual money the business keeps.

Why is Net Profit Important?

Net profit tells you how well a business is doing. Here are the main reasons it matters:

Shows Business Success: 

Even if a company makes a lot of sales, it’s the net profit that shows if it’s actually making money. High sales don’t matter if expenses are too high.

Helps with Planning: 

Net profit is the money a business can use to grow, like buying more products, opening new stores, or saving for the future.

Attracts Investors: 

People who want to invest in a business look at net profit. A high net profit shows the business is strong and worth their money.

Helps Get Loans: 

Banks check net profit before giving loans. A business with a good net profit is more likely to repay loans because it has strong cash flow.

Compares Performance: 

Business owners use net profit to compare their company's performance over time, such as this year compared to last year. They can also compare their net profit to that of other businesses in the same industry.

How to Calculate Net Profit?

To find net profit, you take all the money a business earns and subtract all the money it spends. Here’s the formula:

Net Profit = Total Revenue + Other Income – Cost of Goods Sold – Operating Expenses – Other Expenses – Interest – Depreciation – Taxes

Let’s break down each part:

Total Revenue: The money from selling products or services.

Other Income: Extra money, like interest earned or money from selling old equipment.

Cost of Goods Sold: The cost of making or buying the products sold, like raw materials or labor.

Operating Expenses: Regular costs to run the business, like rent, electricity, salaries, and advertising.

Other Expenses: Any extra costs, like repairs or legal fees.

Interest: Money paid on loans.

Depreciation: The decrease in value of assets, like machinery or furniture, over time.

Taxes: Money paid to the government, like corporate tax.

Example: XYZ Ltd.

Here’s an example from a company called XYZ Ltd.:

Calculation:

• Start with Gross Profit: ₹15,00,000
• Subtract Operating Expenses: ₹15,00,000 – ₹1,00,000 = ₹14,00,000
• Subtract Interest: ₹14,00,000 – ₹30,000 = ₹13,70,000
• Subtract Taxes: ₹13,70,000 – ₹30,000 = ₹13,40,000

So, XYZ Ltd.’s net profit is ₹13,40,000. This is the money the company keeps after paying all expenses.

What is Net Profit Margin?

Net profit margin is a way to measure how much profit a business makes for every rupee of sales. It shows how good a company is at turning sales into profit. The formula is:

Net Profit Margin = (Net Profit ÷ Total Revenue) × 100

This gives you a percentage. A higher percentage means the business is better at controlling costs and making profit.

Example: Company ABC vs. Company XYZ

Let’s compare two companies, ABC and XYZ, to understand net profit margin.

Company ABC Income Statement:

Net Profit Margin for ABC:

• Net Profit = ₹80 crore
• Total Revenue = ₹225 crore
• Net Profit Margin = (80 ÷ 225) × 100 = 35.55%

Company XYZ Income Statement:

Net Profit Margin for XYZ:

• Net Profit = ₹30 crore
• Total Revenue = ₹100 crore
• Net Profit Margin = (30 ÷ 100) × 100 = 30%

Comparison:

• Company ABC has a net profit margin of 35.55%, which is higher than Company XYZ’s 30%. This means ABC is better at turning sales into profit and likely manages costs more efficiently.

Why is Net Profit Margin Important?

Net profit margin is like a magnifying glass that shows how well a business is doing. Here’s why it matters:

Shows Efficiency: 

A high net profit margin means the business is effective at keeping costs low while making sales. It shows that the company is well run.

Helps Optimise Profits: 

By looking at net profit margin, business owners can see where they’re spending too much and find ways to save money.

Attracts Shareholders: 

People who own shares in a company want a high net profit margin because it shows the business can make more money for them.

Compare Businesses: 

Net profit margin lets you compare different companies in the same industry. A company with a higher margin is usually stronger.

Difference from Gross Profit Margin:

Gross Profit Margin shows how much money is left after paying for the cost of goods sold (like raw materials). It doesn’t include other expenses like rent or taxes.

Net Profit Margin includes all expenses, giving a fuller picture of the business's real income.

Conclusion

Net profit is the money a business keeps after paying all its expenses, like goods, rent, salaries, taxes, and loans. It’s a clear sign of whether a business is successful. A high net profit means the company is doing well and has money to grow or save. Net profit margin takes this a step further by showing how much profit comes from each rupee of sales, helping businesses understand their efficiency.

By tracking net profit and net profit margin, business owners can make smart decisions, attract investors, and get loans more easily. Companies with high net profit margins are often better at managing costs and making money, which makes them stand out in their industry.