What is net profit? Meaning, formula and calculator

The net profit formula

• Net profit = sales − cost of sales − operating expenses + other income − interest − tax.
• Net profit before tax is the same without the tax line. Mid-year, a company's Xero figure is usually this one. The profit before tax guide works out the tax due on it and the amount to set aside: about $2,980 a month for a contractor whose year's tax is $35,750.
• Net profit margin = net profit ÷ sales × 100. It lets you compare years when sales have changed. Sales here is your turnover, ex GST or VAT: turnover vs profit shows a workshop with £240,000 of turnover keeping £12,000, a 5% margin.

Each step down the Profit and Loss has its own name. Gross profit vs net profit explains the first and last, operating profit the one in between, and the EBITDA calculator works back up from net profit. To see whether the business itself earns enough before interest and tax, and what margin it needs, use the operating profit margin guide.

Net profit: a worked example

A plumbing company in Adelaide, one year. Made-up figures to show the arithmetic.

	$
Sales	620,000
Less cost of sales (pipes, fittings, hot water units, subcontractors)	248,000
Gross profit (60%)	372,000
Less operating expenses (wages and super, the director's salary, vans, insurance, rent, depreciation)	290,000
Operating profit	82,000
Add interest received	1,000
Less interest on the van loan	7,000
Net profit before tax	76,000
Less company tax at 25%	19,000
Net profit (9.2% of sales)	57,000

Check: 620,000 − 248,000 = 372,000; 372,000 − 290,000 = 82,000; 82,000 + 1,000 − 7,000 = 76,000; 25% of 76,000 is 19,000, the rate for a small Australian company; 76,000 − 19,000 = 57,000, which is 9.2% of sales.

What it says to the owner:

• The 57,000 is not all theirs to take. During the year the company paid 30,000 of dividends and repaid 14,000 off the van loan. Neither is an expense, so neither lowered the net profit, but both took cash. 13,000 of the profit stayed in the business.
• The overheads are where the profit goes. The work earns 60 cents of gross profit per dollar of sales, and overheads take 47 of them. A 10% rise in overheads, about 29,000, would cut net profit before tax by more than a third.
• The bank balance will not match. If customers owed 20,000 more at the end of the year than at the start, the company has that much less cash than the profit suggests. The profit but no cash explainer finds where the gap went.
• Whether 9.2% is good depends on what the business needs. There is no single good margin across trades. What is a good profit margin for a small business works out the margin a business needs to pay the owner fairly, cover the tax and fund what it must reinvest, with a landscaper making 21.4% that needs 27.4%.

Press "Load the worked example" above to see it in the calculator.

What is not in net profit

• Drawings and dividends. Money the owners take out is a share of the profit, not a cost of earning it. How much can I pay myself works out a safe amount from your Xero figures.
• A wage for your own time. A sole trader's work is not an expense, so the net profit pays for the owner's labour as well as being the return on what they put in. True profit takes off a market wage and a return on capital, with a worked example.
• Loan principal. Only the interest is an expense. The rest of each repayment reduces the loan on the Balance Sheet.
• Equipment you buy. A 60,000 van is not a 60,000 expense in the year; it shows as depreciation spread over its life.
• GST or VAT. In Xero the Profit and Loss is shown without the tax you collect and pay on sales and purchases, if you are registered.
• A sole trader's income tax. It is personal, so it never appears in the business Profit and Loss. Set part of the net profit aside for it. The tax is not worked out on Xero's net profit as it stands: trading profit shows the adjustments (entertainment, private use, capital allowances) with a worked example.

Finding net profit in Xero

1. Go to Accounting › Reports › Profit and Loss and pick the period. Net Profit is the last line. How to read a profit and loss in Xero goes through each section.
2. Xero shows Trading Income, Cost of Sales, Gross Profit, Other Income, Operating Expenses and then Net Profit. Interest paid sits in Operating Expenses in the standard chart of accounts, so take it out of the expenses figure you enter here.
3. For the net profit margin over time, the Profit and Loss by month shows whether it is rising or falling. If it fell, why did my profit drop covers finding the cause.
4. If the year ends in a net loss, the tax loss is usually a different figure and can reduce tax in later years. Net operating loss shows a $40,000 loss in Xero becoming a $44,000 tax loss that saves $11,000 the next year.

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