Difference between Gross Profit and Net Profit - Research Paper Example

A Profitable Business Difference between Gross Profit and Net Profit Gross profit enables the business owner or investor to assess the profitability of the production process whereas net profit is a measure of the profitability of the business as a whole. Gross profit is calculated by subtracting the cost of producing goods from the revenues earned by selling those goods to customers (Pride, Hughes, and Kapoor 513). The cost of goods sold (COGS) includes the cost of raw materials, purchases of items used in the manufacturing process including wages of production staff, carriage inwards. After adding up these costs, the value of unsold goods (closing stock) is deducted to give the cost of goods sold. When the COGS is deducted from total revenues from sales, the gross profit is achieved. Gross profit is also known as operating profit because it is a measure of the manufacturing operations of the business. Net profit is calculated after deducting general, selling and administrative expenses from the gross profit. These expenses include items like electricity expenses, depreciation, salaries of office staff, and other expenses related to the day to day running of the business (Pride, Hughes, and Kapoor 513). Sometimes, other income such as interest on loans, etc. is added to the gross profit. The net profit is a measure of the profitability of the business as it represents the amount that would be shared among the shareholders. For this reason, investors use net profit to determine the earnings per share (EPS) by dividing the net profit by the number of outstanding shares. This tells investors how much return each share of the business earns for shareholders. 2. Misconceptions about Revenues and Expenses A common misconception new business owners have about revenues is that they are the same as profit. Revenues measure what a business received by selling its products. Profit is calculated after deducting expenses from revenues. Revenue is also not the same as income because income also includes payments a business receives other than by selling its goods and services. Rent received by letting out factory space or interest received on loans given out are part of the income of a business and not its revenue. Secondly, when accounting for business operations, the amount of revenue and expenses reported may differ. Under the cash-based accounting method, revenues and expenditures are identified when cash is collected or paid. But under the accrual accounting system, revenues and expenditures are identified when the right to receive or duty to pay has been established. The cash may be received at a later time. New business owners also sometimes fail to distinguish expenses from costs. For accounting purposes, cost is usually used to mean the price of a long-term benefit such as a fixed asset. On the other hand, expenses such as electricity payments and office stationery are payments in the course of the normal running of the business. Some new business owners also hold a misconception that all expenses involve payment of cash. In some cases, such as depreciation expense, there may be no payment of cash. Depreciation and amortization expenses simply involve the spreading of a cost over the period during which the benefits of the cost are realized by the business. 3. Business Management Software InFlow is one of the most popular inventory management software for small and medium-sized businesses. Launched in 2007, it allows for products to be organized into categories with picture and price identification. Furthermore, the system also allows items to be tracked at the aisle and bin level. It supports bar code scanning for efficient point of sale operations. Users can have real-time access to the updated data. The system also produces invoices, purchase orders and other documentation. Customized sales, profit and cost reports can also be produced. The company offers a free edition of the software that has a capacity of storing up to 100 products (InFlow, 2013). QuickBooks is a well-known accounting software. Once installed, it can import customer records from Microsoft Excel and Outlook. It keeps all financial records updated, which is very useful for tax computation purposes. The software allows the business to track customer payments, invoices and payments received. It can also be used to download data from the bank so that credit card payment and check transactions can be tracked. For financial accountants, the software is helpful in making financial projections and preparing budgets. The software can also be upgraded to include inventory management procedures (QuickBooks Online, 2013). CheckMark is a Windows and Mac-compatible payroll management software. The software can be used by small as well as large businesses. The software allows for salary computation and tax calculation. It also allows direct deposit of salaries into bank accounts. The software is freely downloadable and has no monthly charges (CheckMark, 2013). Up to eight additional incomes and sixteen deductions can be calculated for an employee with the 2013 version. Up to 50 local tax categories and 200 state tax categories can be managed. 3.1 Choice of Preferred Software My preferred software out of the three is QuickBooks. I prefer it because it is flexible and can be used for a variety of applications including accounting, payroll and inventory management. This makes better coordination possible among several departments to increase efficiency. It is also suitable for small as well as large business as it can be upgraded and is scalable. 3.2 Additional Costs The QuickBooks Master Program for Accountants starts at $319.95 (Intuit, 2013). During the first thirty days after registration, free support is available. Free support is also available for installation, upgrading and error problems. Paid 24/7 assistance is available for queries, customization and data recovery issues and users can choose from a $299.95 annual plan or an $89.95 three-month plan (Intuit, 2013). 4. Pricing Products and Services for Profit In pricing products and services, the business must consider the profit margin of the industry and the market. Each industry operates within a certain profit margin that allows it to charge a price to cover overhead expenses and earn a profit. Direct cost margins help to cover costs related to the product or service whereas profit pricing allows the business to earn a profit. To determine the profit price for any product or service, the direct cost per unit is added to the measure (fixed costs + desired profit)/volume (Entrepreneur, 2002). The desired profit may depend on the profit margin of the industry, market or product. It may also be higher if the product or service is highly differentiated or novel. 5. Pricing Products and Services to Compete In competition-based pricing, the business may determine as its objective to attract customers away from the competition, to increase the number of customers served in the market, or to make the product or service seem similar to the competition (Pride, Hughes, and Kapoor 385). In the first instance, the business adopts a market penetration strategy where the price is set lower than the competition for a similar product. In the second case, the business follows a market share strategy where the price is set to attract the largest number of customers in the market to become market leaders. This helps to achieve economies of scale (Pride, Hughes, and Kapoor 385). In the third case, the business prices its product or service at the same level as the competition. This creates the impression that the two products or services are price substitutes. 6. Pricing Scenarios in Sluggish, Average and Strong Markets Assuming that there are equal chances of the market being sluggish, average, or strong, the following table shows the pricing scenario: Scenario Estimated sales volume Estimated price ($) Sluggish 75,000 9.00 Average 100,000 7.00 Strong 150,000 5.00 Works Cited “CheckMark Payroll” Checkmark. CheckMark, n.d. Web. 20 Jan. 2013. “Features” InFlow Inventory. InFlow Inventory, n.d. Web. 20 Jan. 2013. “Intuit QuickBooks Accountant 2013” Intuit Accountants. Intuit Accountants, n.d. Web. 20 Jan. 2013. “Pricing Your Product.” Entrepreneur. Entrepreneur, 22 Jul. 2002. Web. 20 Jan. 2013. Pride, William M., Robert J. Hughes, and Jack R. Kapoor. Business. Cengage Learning. 2012. Print. Read More