We all know that sales are an indicator of the success of your business. There is a more important measurement to look at, however – net profit. What exactly is net profit?
Net profit is the amount of money that is left after you subtract your total business expenses from your total revenue. In other words, it is a calculation that includes almost all financial transactions in your business. If total expenses and charges are greater than revenue, the business incurs a net loss, if expenses and charges are less than total revenue, it has made a net profit. Expenses are what the company spends.
The notable exception is tax – net profit does not include tax payments as tax calculations are based on a percentage of your net profits, i.e. the net profit figure is required before the tax calculation can be done.
A low or negative net profit is indicative of various issues such as fewer sales, poor management of expenses, poor marketing, ineffective pricing, poor customer service experience from employees and more. A high or positive net profit can be attributed to several favorable variables.
It’s important to note that net profit will vary depending on the industry you’re in and the company you work for.
How to Improve Net Profit
- Reduce overheads – reducing overheads can give you a one-off or an ongoing reduction in costs, depending on the overhead. Examples include saving on your telephone bills, travel expenses, staff salaries, and more.
- Reduce the cost of goods sold – this includes things like negotiating better prices with suppliers, making the manufacturing process more efficient, outsourcing, and more.
- Increase sales volumes – to spread costs in your business as far as possible.
How to Calculate Net Profit
There are various formulas you can use to calculate net profit.
Net profit represents the number of sales dollars remaining after deducting the following:
– All operating expenses
– Preferred stock dividends (but not common stock dividends)
– These are deducted from the company’s total revenue and provide net profit.
Why is net profit so important?
The net profit margin is important to evaluate in lending decisions because it effectively shows the firm’s potential net worth based on earnings. This has a direct effect on capital reserves, which means the higher the profit margin, the more likely the business will be able to remain resilient in periods of unexpected losses. As a business owner, net profit helps you to assess where you stand financially in comparison to other similarly related businesses.