Difference between Gross Profit and Net Profit
In online trading, looking at the financial health of a company is important to assess if buying its shares is a good option or not. And, when we talk about the financial health of a business, the first thing that comes to mind is profit.
If the company is earning good profits, then it should be financially strong, right? But, where do you find information about how much profit a company is making?
You look at its financial statements. This is where you are surrounded by terms and jargon that need some explaining. With time being of the essence in intraday trading, it is important to understand these terms. Two such terms are gross profit and net profit that we will attempt to explain. We will also highlight the difference between gross and net profit.
What is Intraday Trading?
Intraday trading is a fast-paced environment where traders take positions on stocks based on their assessment of the direction the stock price could take. To start intraday trading, you need to open a trading account with a stockbroker. There are various brokerage plans to choose from based on your trading preferences. You can opt for a trading account with a percentage-based plan, a flat-fee plan, or a ‘pay only when you profit’ plan. In the pay only when you profit plan, the broker charges brokerage only for profit-making trades.
Gross Profit and Net Profit
In the simplest terms, gross profit is the difference between revenue and costs. So, if a company spends ₹500 on manufacturing a product and bringing it to the customer and generates revenue of ₹700, then the gross profit is ₹200.
On the other hand, net profit is when you deduct expenses, taxes, and interest paid from the gross profit.
Difference between Gross Profit and Net Profit
Here is a quick look at the difference between gross and net profit:
|Formula||Uses||Inclusions and Exclusions|
Gross Profit =
Revenue – Cost of Goods Sold or COGS
Gross Profit is used to estimate approximate profits and can help minimize costs.
Gross Profit calculation factors in the overhead costs and associated taxes but excludes the overall operating expenses and interest paid by the company, which is included in the Net Profit calculation.
Net Profit =
Gross Profit – Expenses (including tax, interest paid, etc.)
Net Profit is used to determine actual profits and can help estimate the efficiency of the company in turning sales into profits.
Why is it important for stock investors to know about the difference between gross profit and net profit?
As a stock investor, analyzing the financial statements of a company is essential to determine its reliability and profitability. By understanding the difference between gross and net profit, you can get a clearer picture of the company’s financial performance and make informed decisions.
Using gross and net profit, you can also determine the gross and net profit margin ratios that offer the following insights:
- Gross Profit Margin Ratio: Is the company managing its labour, raw materials, and equipment efficiently? A higher Gross Profit Margin Ratio implies that the company is better at managing its costs to ensure profitability.
- Net Profit Margin Ratio: How is the company performing in comparison to its peers? A high Net Profit Margin Ratio implies that the company is managing to sell its products with a high profit margin.
Before you start online trading or open a trading account, ensure that you understand these aspects. The stock market is a high-risk environment, and if you are opting for intraday trading, then you will have very few opportunities to recover from an erroneous decision.
While a pay only when you profit brokerage plan can help reduce losses, understanding the difference between gross profit and net profit can help you take a better intraday trading position.
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Frequently Asked Questions
Intraday trading is based on the movement of the market price of a stock. A company with a high Gross and/or Net Profit will attract the attention of a lot of investors and traders. This will boost the volume of trade in the stock and also contribute to the volatility in its price.
If a company has a high Gross Profit, then it is managing its COGS efficiently. However, low Net Profit implies that its other costs are high enough to eat into the revenue earned via sales. Hence, you might want to research the company more before making a decision.
A trading account with a ‘pay only when you profit’ brokerage plan ensures that you don’t pay brokerage if you are making a loss in your trade. The broker will take the average market price of the open position when you are closing it and not charge brokerage if the trade is loss-making. This helps minimize losses when the markets move contrary to your expectations.