Financial success is a priority for all business owners. After all, we start businesses to generate profits. Staying on top of profits is a smart financial habit that helps you understand how well your organization is doing financially. For this reason, net income and profit are terms that all business owners need to understand.
Although both terms refer specifically to amounts of income, they have different meanings. Net income, sometimes referred to as “net profit”, is a single number that represents a specific type of profit. On the other hand, profit is the total amount of revenue after deducting business expenses. Net income is generally considered a company’s bottom line, while profit is often used to determine tax liabilities and financial health.
We will explore net income and profit to help companies better understand these crucial financial markers.
What is net income?
Net income, also known as net profit or net profit, is equal to the sum of total income after deducting expenses. Net income is derived from various calculations, including total income, expenses, and income streams during a given period. Additional flows include asset sales, asset depreciation, one-time special event payments, and taxes. Expenses can include costs associated with manufacturing products or interest paid on business loans.
Since net income is calculated after expenses, it is considered an excellent indication of your business’ financial condition. To make sure your net income is accurate, you’ll need to track income and expenses consistently. Over time, you can compare each year’s net income to determine if the business has grown as expected or has remained stagnant.
Analysts and investors who use net income to aid in company valuations often consider specific calculations used to determine the company’s taxable income in addition to net income totals. Indeed, net income figures can be manipulated by concealing expenses or other unethical techniques.
What is profit?
Profit is the financial gain that your business retains after you take care of expenses, taxes, and other associated costs. To calculate your profit, subtract your total expenses from your income. Profit is important because it tells the owner how the business operates.
If your business has revenue, you have profit, but separating your profit into categories helps to calculate the true financial position of your business.
There are three different types of benefits:
- Gross profit
- net profit
- Operating result
List each type of profit on your company’s income statement to give stakeholders insight into your company’s overall performance. Here’s a closer look at how each type of profit is calculated and why those numbers are crucial.
Gross profit, or gross revenue, is the total revenue from sales after subtracting all costs involved in making and selling goods. For service companies, this would be the profit after subtracting the costs of providing the service.
Gross profit totals are useful when looking at variable costs within your business. Variable costs are all costs that fluctuate with production levels. Gross margin does not include fixed costs, such as human resources or equipment.
Here are some examples of variable business costs:
Total sales is usually the first item in an income statement, followed by cost of goods sold. Here is the gross profit formula:
Total sales – cost of goods sold = gross profit
After you deduct all expenses, including taxes and interest, the remaining income is called net profit or net income. Owners and stakeholders often rely on net profit figures to provide the most accurate picture of a company’s financial condition.
In some cases, however, the net profit figure can be misleading. While net profit shows how much cash a business generates, profitability also depends on how the cash generated is invested.
Here is the formula you would use to determine the net profit of your business:
Operating profit – taxes and interest = net profit
Before determining your net profit, you need to calculate your operating profit. Operating profit is the amount that remains after subtracting operating costs from gross profit.
Unlike gross profit, operating profit includes both fixed and variable operating costs. Your business operating expenses can include administrative costs and costs related to general business needs.
Operating profit is often referred to as “EBITDA”, which stands for “earnings before interest, taxes, depreciation and amortization”. Here is the formula you would use to calculate operating profit:
Gross profit – operating expenses = operating profit
Profit in small business
In the small business world, profit is considered direct income. If your income statement shows a higher expense figure than profit, this is the #1 indicator of financial loss.
To get the most accurate picture of your company’s financial situation, take the time to analyze the three types of profits. This analysis is done through profit margin, a ratio of your organization’s profit divided by its revenue. The profit margin will give a detailed overview of how your business handles incoming revenue.
Example of Net Income vs. Profit
Profit can be used as a general reference to several different numbers, while net income is a specific type of profit.
For example, suppose Company Z has listed its gross profit for 2021 as $100,000. This figure is equal to revenue less cost of goods sold.
However, Company Z’s net income is reported as $45,000. This total is the amount left over after operating costs and tax payments have been deducted from the gross profit of the business.
How to Track Net Income and Profit
The best way to track your business’s net income and profits consistently and accurately is to use accounting software. While most software vendors offer to track totals, business owners should evaluate the reporting capabilities of any accounting solution.
We’ve compiled a list of the best accounting software, but the provider you choose will ultimately come down to what’s most important to your business. Take a closer look at three great accounting software solutions for small businesses.
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 features to support almost any type of business.
Here are some of the main features of QuickBooks Online:
- Automatic bank feeds: QuickBooks comes with automatic bank feeds to help you track transactions.
- Direct billing: QuickBooks includes a Gmail app feature to send invoices directly from your email.
- Online accounting service: You can use an online accounting service for a fee of $500 and a monthly rate based on your average expenses.
- Inventory features: Depending on the plan you choose, QuickBooks also provides inventory management. You can add inventory images, track inventory through software, and group items that are often sold together. This feature is particularly useful for companies that manage large amounts of inventory.
For more information, read our in-depth review of QuickBooks Online.
If you run a project-based business, FreeAgent should be on your list as an accounting software option. Here are some of the features of FreeAgent:
- Recurring invoices
- Automatic thank you emails following customer payments
- Software timer for tracking time spent on projects
This software also offers a bank reconciliation tool that makes it easy to reconcile transactions. Reporting is simple, with the ability to run detailed financial reports such as profit and loss statements and balance sheets. FreeAgent comes with a mobile app to help you constantly track your account activity, claim miles, and keep tabs on billable time.
For more information, read our full FreeAgent review.
If your business operates on a very small scale – with less 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 vendors. While ideal for very small businesses, Zoho Books can scale with growing businesses and organizations of all sizes.
Here are some of the features we love:
- The ability to convert quotes and orders into invoices
- The ability to schedule invoices to be sent later
- The possibility of sending invoices by post
- Compatibility with payment processors like PayPal, Braintree, Stripe and Square
For more, read our in-depth Zoho Books review.
Avoid the temptation to process financial data manually
Regardless of the size of your business or your industry, accounting software is one of the best tools for tracking profitability. It can be tempting to start processing financial data manually, especially if you run a micro business. But human error is inevitable, and it helps to have an automatic process in place before your business begins to scale. Evaluating different types of profits can be complex, and good software is your best bet for keeping analyzes as simple as possible.