Gross profit and net income are metrics that show the profitability of a company are derived from a company's income statement. Net income and gross profit have different characteristics that are important to consider before investing.
Gross profit is a company's profit earned after subtracting the costs of producing and selling its products. Gross profit is calculated as shown below:
Gross profit = Revenue - Cost of Goods Sold
Revenue is the total amount of money earned by a company for a period. Revenue is sometimes listed as net sales because it may include discounts and deductions from returned merchandise. Revenue is called the top line number since it sits at the top of the income statement.
Cost of goods sold or COGS is the direct costs involved with producing goods. COGS includes both direct labor costs, and direct materials costs used in the production of a company's products.
Gross profit measures how well a company generates profit from their direct labor and direct materials. Some of the costs include:
- Direct materials
- Direct labor
- Equipment costs used in production
- Utilities for the production facility
- Shipping costs
Net Income is a company's profits or earnings. Net income is also called the bottom line since it's located at the bottom of the income statement.
- Net income is the profit after all expenses have been deducted from revenues. Expenses can include interest on loans, general and administrative costs, income taxes, interest, depreciation, and operating expenses such as rent, utilities, and payroll.
- Net income includes additional income streams such as interest on investments or proceeds from the sale of assets.
Example: Comparing Gross Profit and Net Income
J.C. Penney Company Inc. (JCP)
Below is the income statement for J.C. Penney for 2017 as reported on their 10K annual statement.
- Revenue and Net Sales were $12.50 billion.
- Gross Profit was $4.33 billion or (total revenue of $12.50B - COGS of $8.17B).
- Net income (loss) was -$116 million (a loss).
The Bottom Line
We can see that J.C. Penney earned $4.33 billion in gross profit, but after taking out the remaining expenses including SG&A and the interest cost of their debt, the company suffered a loss of $116 million.
When most people refer to a company's profit, they are not referring to gross profit, but instead are usually referring to net income which is the remainder after expenses, or the net profit.
The example above shows why it's important to analyze a company's financial statements using multiple metrics to determine whether a company is performing well or suffering a loss as in the case of J.C. Penney for 2017.
For more on revenue and net profit with an example using Apple Inc. (AAPL), please read "The Difference Between the Top Line and Bottom Line."