11. Gross Profit vs Net Profit

Let's talk about gross profit. Like I've said before, accounting words are regular words. So what does this word gross mean? Well, why don't we look this one up on Google? Okay, gross means unattractively large or bloated. That's not right. Gross means without deduction of tax or other contributions, total. Total, whole, entire, complete, full, overall, combined, aggregate. What we're going to focus on here is without deduction.

So gross profit, the formula for gross profit is sales minus the cost to make the sales, which we call cost of goods sold. That gives you your gross profit. So you can see here we are just taking the total sales numbers minus the cost to produce whatever it is we sold. We're not taking out anything else. We're not taking out rent. We're not taking out insurance, salaries, wages, anything like that, because it is truly without deduction. It is the highest number that our profit could be. So let's quickly talk about cost of goods sold, because this may be the first time that we've talked about it here.

So if you have sales of $1,000, let's say you sold $1,000 in funny hats, but those funny hats cost you $600 to make, well, then that's your cost of goods sold. You got $1,000 in revenue, but you didn't really make $1,000 because you spent $600 manufacturing the hats, right? So then that leaves $400 as your gross profit. So you may be asking yourself now, if gross profit is without deduction, is there a profit that is with deduction? And the answer to that is definitely, and that one is called net profit.

But you normally see this as net income. So if gross profit is profit before the deduction, then net profit or net income is profit after all the deductions. Let's take a look at that. So Google has this to say: net profit is the actual profit after working expenses not included in gross profit have been paid. And this is the key part, after working expenses. So net income is gross profit minus working expenses. Let's take a look. So you have sales, $1,000 hilarious hats. You have cost of goods sold.

So you take out whatever it costs you to make. You got $400 left. Okay, that's your gross profit. Now, this $400 has to last you through all your operating expenses. So you've got all these operating expenses here. And you get to the very bottom and you've got net income or net profit. I'm just going to call it net income. You've got net income of $100. So after all of these things have been paid, your net is $100. So what are some of these things? Well, this is whatever it takes to run your business.

So this could be rent. This could be salary. This could be wages, advertising, insurance, all that kind of stuff. So if you're running a business, you're not just producing the widgets. You also have to pay the people that are producing it. You have to pay the place where you're producing it. You have to do some marketing. You have to get insurance, right? So all of this stuff is called operating expenses.

And that should be pretty straightforward as to why, because it's expenses incurred during the operations of your business. So this $400 has to last through all of those. And you finally get down here and you've got $100 in net income. So that's why you may see something on the news of like, well, the company had, let's say, $1 billion. Let's call it 10. They had $10 billion in sales, but it costs $9 billion to produce whatever it is they're producing. So their gross profit is $1 billion. Well, that sounds pretty good. But when you have a company of this size, these operating expenses could be crazy high.

So they could get to the bottom line and still lose money. I mean, it's possible they could be losing $500 million. And so your gross profit has to be high enough or your operating expenses have to be low enough that at the end of the day, after paying it all, you've still got net income left over. So let's take a look at these definitions. We'll wrap it up here. Gross profit is the amount of income without deduction.

It's just sales minus cost of goods sold gives you your gross. Opposite of that, you've got net profit, which is net income. And that's the actual profit after all those expenses that we did not take out. This one says without. So that's all the stuff we left out. That gets included when we're talking about net profit.

And so if you look at it, you've got sales less COGS gives you gross profit and you work your way down through all the operations and that gives you net profit.