How is Net Profit Calculated?

In simplified terms:

• Net profit = Revenue − (cost of sales + operating expenses + other expenses)

Depending on reporting format, net profit may be shown:

• Before tax (profit before tax)
• After tax (profit after tax)

It’s important to be clear which one is meant in a given report.

What net profit includes

Net profit generally reflects:

• Revenue from sales (and sometimes other income)
• Direct costs (cost of sales)
• Operating expenses (payroll, rent, marketing, admin)
• Depreciation/amortisation
• Finance costs (interest), if applicable
• Taxes, if reporting net profit after tax

Why net profit matters (and where it misleads)

Net profit is a key indicator of profitability, but it can diverge from cash reality. Common reasons include:

• Customers haven’t paid yet (receivables rising)
• Inventory increased (cash spent, costs not yet recognised)
• Large non-cash charges (depreciation/amortisation)
• One-off items (asset disposals, impairments, restructuring)

That’s why net profit is best interpreted alongside:

• Cash flow
• Balance sheet movement (working capital)
• Key margins (gross margin, operating margin)

‍

1. Is net profit the same as net income?
   Often yes, but naming depends on region and reporting style. Always confirm whether it’s before or after tax.
2. Can net profit be positive while cash is negative?
   Yes. Accrual accounting recognises revenue/expenses before cash moves, so timing differences can create profit without cash.
3. Is net profit the best measure for performance?
   It’s important, but not sufficient alone. Operating profit, cash conversion, and working capital trends often explain performance more clearly.

‍