If you are running an eCommerce business, it’s useful to understand the differences between profit, net profit, gross profit, and net profit margin.
So we’ll take you from easy to complicated.
First of all, let’s talk about profit. Profit is calculated by deducting the cost of a good or service (where cost is the money spent on manufacturing the good or developing the service) from the price a consumer pays for that specific product or service. Although the formula you need to use to calculate profit is pretty simple and straightforward, you can also use a profit calculator formula to be sure of the accuracy of the results. Here’s how you find out what your profit is:
Profit = Price – Cost (for one unit sold)
Total profit = Revenue – Total cost or Total profit = (Unit price x Quantity) – (Unit cost x Quantity) (for larger volumes)
Then, there comes the net profit. In the simplest way possible, net profit is the money you have left (usually at the end of the fiscal year) after you have paid all the other expenses. And since revenue increases don’t always reflect an increase in profitability, net profitability is the best metric to help you measure the success of your eCommerce business.
Sustainable growth means having a consistent increase in net profit month after month. The basic formula for calculating net profit is determining the total revenue, then subtracting the total expenses from it. These total expenses can be broken down into indirect and direct costs. Indirect costs (like the cost of electricity, rent, and utilities) are harder to assign to the manufacturing of a specific product. Similarly, direct costs are split into fixed and variable expenses.
The variable costs are the costs of goods sold, with everything they entail (materials, packaging, delivery, the cost of the equipment required to produce a unit of the product, the salary of project-based contractors, marketing and advertising, and so on). They vary over time because the number of product units you sell is unlikely to stay the same over time. The fixed costs are those you pay month by month and are unlikely to change, regardless of how much you produce or sell (rent, salaries, property taxes, insurance, equipment depreciation and maintenance fees, etc.).
Gross profit vs. net profit
Gross and net profit aren’t the same things. Gross profit is the profit a business makes at the end of a certain period after deducting all the costs related to manufacturing and selling its products or services. It only includes the variable costs mentioned above but doesn’t take into account the fixed costs. Gross profits show you how effective your business is in using the resources at its disposal to manufacture and sell goods (or services) to its clients. Moreover, it helps you keep things in check by knowing the exact costs that are needed to generate revenue. When the value of the cost of goods increases, the gross profit decreases, and the other way around. Having a lower value of the cost of goods is a good thing for your business because it means it leaves you with more money to spend on other business operations.
And then there’s the net income, also called net earnings, that takes into account all expenses and tells you how “healthy” your business is, financially speaking. According to Investopedia, to calculate net income, you need to extract the cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses from the sales.
Even though they may sound more or less the same, profit and profitability are not the same thing. You can find the profit in the form of an absolute number by subtracting the expenses from the revenue. Profitability is a relative number, a percentage, which relates to the ratio between revenue and profit and tells you a great deal about efficiency. It is also an indicator that predicts the success and the failure of a business. Net income is one of the values that point to the profitability of your business.
How to calculate net profit
Net profit calculation is probably the easiest thing to grasp when you’re analyzing your financial data. Here’s the net profit formula, as simple as can be:
Net Profit = Total Revenue – Total Expenses
You should take into account all the expenses, not only those related to the cost of production of your goods, as mentioned above, including interest, taxes, the depreciation of your equipment, utilities, and payroll.
Why is net profit so important?
There are plenty of reasons why net profit is important for your business. First of all, sales revenue doesn’t tell you much about the health of your business. If you look at this number, it may feel like your business is doing pretty well. But at a closer look, you’ll see that things aren’t as shiny as they seem. Having lots of sales doesn’t automatically translate into making a great profit. Net profit is an indicator of the success of your business and also one of the first things investors and shareholders look at upon deciding whether or not it’s worth investing in you or making business with you.
Net profit is also important from the perspective of investing back in your business. If you think about expanding your activity or improving the operations in various sectors of your business, you’ll need to know how much money is available to sustain these plans. Moreover, banks and other creditors look at your net profit when you apply for a loan. For them, it’s an indicator of whether or not you can pay back that loan.
But, above all, it’s relevant because it makes you take a closer look at all your business’s expenses and the taxes you need to pay. By knowing how much revenue you get from sales and how much is lost after paying everything that relates to the direct and indirect costs, you can also decide on a better pricing strategy or other tactics that might increase your revenue in such a way that, at the end of the day, you’ll be left with enough money to keep your business growing. The strategies that help you improve net profit can be broken down into strategies to increase sales revenues and strategies to decrease costs.
Strategies to increase sales revenues:
- Develop new product lines
- Find new customers who might be interested in your products or new markets to expand your activity
- Find ways to increase your prices without it affecting your current customer base
- Look for ways to increase the average transaction size
- Look for ways to increase the frequency of the purchases per customer
Strategies to decrease costs:
- Use stock control to streamline your business
- Find the right suppliers for your business and look for ways to negotiate a better price for the services or raw materials you need
- Decrease indirect costs by minimizing waste and errors in your business; this may mean extensive training for your staff to align their performance with this business logic
- Decrease overheads wherever possible
- Benchmark your key financials to see whether you are paying too much in a certain area of your business
How to calculate net profit margin
Essentially, the net profit margin is the ratio that tells you the percentage of profit your business makes from its total revenue. You can use the net profit to determine how much of each dollar you collect in revenue translates into real profit. The net profit margin formula looks like this:
Net Profit Margin = Net Profit ⁄ Total revenue x 100
Or, in a more sophisticated manner, like this:
Net Profit Margin = (R-COGS-E-I-T) / R x 100
= Net income / R x 100
- R = revenue
- COGS = cost of goods sold
- E = operating and other expenses
- I = interest
- T = taxes
It’s important to use a margin formula to calculate your expenses and keep track of your revenue but also to get the “full picture” of the overall performance of your business. Tracking your company’s net profit margin enables you to assess whether your current tactics and strategies are working and also make predictions about future profits based on revenues. Plus, since companies express this indicator as a percentage, it makes it easier to put side by side two or more businesses and compare their profitability, whatever their size may be.
Profit margins can be affected by your marketing strategy, the sales earnings, your merchandise costs, but also by inventory numbers and taxes.
Improve net profit with an eCommerce automation tool
To improve net profit, you will have to either increase revenue or cut down on the total expenses. Or both. In this particular case, it’s important to find a tool that helps you manage your customer base, provides you with actionable insights that you can use to improve your marketing strategy and automates most of the processes that are linked to the calculation of your profit. Reveal by Omniconvert is the first customer value optimization platform on the market and it might be just what you need.
It uses RFM segmentation (revenue, frequency of purchase, monetary value) to break down your customer base into categories ranging from the most important to your business to the least impactful ones so that you can focus and direct your marketing efforts towards the most valuable customers, thus optimizing the costs for digital marketing and advertising. Moreover, you can also focus on the quality and health of your product catalog by monitoring the product performance. This way, you can keep your inventory clean and eliminate those products for which there is no demand.
Reveal also helps you with your retention efforts and provides you with options to improve customer experience. And the benefits don’t stop here: its eCommerce analytics feature allows you to monitor the most important KPIs for your business in real-time so you stay agile and adapt your tactics and strategies depending on their values. It also shows you the gross margins so you can see the profit generated by each product sold and has an integrated net revenue calculator.
Focusing on retention, increasing the average order value, and minimizing the customer acquisition costs are among the best strategies to improve your net profit. This is why, as an eCommerce business owner, you need an automation tool like Reveal. It does way more than your average analytics tool, offers you accessible, easy-to-read, and accessible reports, and can be integrated with the biggest eCommerce platforms, such as Shopify or WooCommerce. It works great coupled with Klaviyo, an email and SMS marketing platform focused on helping your business grow, and soon enough you will be able to connect Reveal with Facebook and Google for more powerful ad campaigns.
Now that we have exemplified the differences between profit, gross profit, net profit, and net profit margin, we hope it’s all clearer for you and that you understand how important is net profit as an indicator of the overall health of your business. Moreover, we have shown you how eCommerce automation tools, such as Reveal by Omniconvert, can help you increase your net profit, through several strategies, such as RFM segmentation, personalization, and product performance monitoring. Now it’s your turn to make the best decisions for your eCommerce business, in light of what you’ve found out from this article.
Use this formula to calculate net profit:
Net Profit = Total Revenue – Total Expenses
Net profit is an indicator of the health of your business but also a way that enables you to see what works and what doesn’t work (in terms of strategy, tactics, marketing, advertising, product inventory, pricing, and so on). Moreover, by looking at the factors taken into account while calculating net profit, you can get a sense of what you need to do to increase sales revenues and decrease costs.
Finally, net profit is the money you have left (usually at the end of the fiscal year) after you have paid all the other expenses. And because revenue increases don’t always reflect an increase in profitability, net profitability is the best metric to help you measure the success of your eCommerce business.