Understanding the Differences between Turnover, Gross Profit, and Net Profit for Small Businesses

When running a small business, you need to keep track of many financial terms and metrics, including turnover, gross profit, and net profit. These terms may sound similar but have different meanings and implications for your business. Understanding the differences between turnover, gross profit, and net profit is crucial to making informed financial decisions.

This blog post will define and explain the differences between turnover, gross profit, and net profit. To help, we have also added a simple example.

What is Turnover?

Turnover, also known as revenue, is the total amount of money a business earns from sales, services, or other activities (total sales). Turnover represents the top line of a company’s income statement without considering any expenses or costs of goods sold. Turnover is an essential metric for businesses as it indicates their operations’ overall size and scope. The higher the turnover, the more revenue the company generates.

What is Gross Profit?

Gross profit is the amount of money a business earns after deducting the costs of goods sold (COGS) from its turnover. COGS are the direct costs of producing or selling a product or service, such as raw materials, labour, or shipping expenses.

Gross profit is a crucial metric for businesses as it shows how effectively they manage their cost of goods sold and generate profits. A high gross profit margin indicates that a business can produce and sell products or services at a profit. Conversely, a low gross profit margin can be a warning sign that it is not managing its costs effectively.

What is Net Profit?

Net profit, also known as the bottom line, is the amount of money earnt after deducting all expenses, including COGS, operating expenses, and taxes, from its turnover. Net profit is the most accurate measure of profitability as it considers all expenses and costs associated with running the business.

A high net profit margin indicates that a business generates profits after all expenses are accounted for. However, a low net profit margin could indicate that a business is facing financial difficulties or investing heavily in growth.

Now we have looked at all three terms; we will show some examples.

Turnover vs Gross Profit

A business that sells computer equipment and consultancy, during the tax year, they sell £25,000 of computers and £5000 in consultancy. The total turnover is, therefore, £30,000.

To make the turnover, there are costs involved in both purchasing the computers (cost of goods sold) and salaries for the consultants. In the example, they purchased the computers at £15,000, and wages were £1,500. The total costs are, therefore, £16,500.

To calculate gross profit, you deduct the costs against the turnover.

In this example, the gross profit calculation is the turnover of £30,000 less the costs of £16,500, leaving a gross profit of £13,500.

Gross Profit Vs Net Profit

We have already calculated that the business has a gross profit of £13,500, but many other costs are involved in running a business. The net profits are calculated by taking the gross profit minus all the costs.

Other costs can include insurance, rent, utilities, printing, advertising and any additional costs that the business occurs in running it.

Continuing to use the same example, the small business had a gross profit of £13,500. All the other costs of the company were £10,000. This would leave a net profit of £3,5000.

Example Income Statement (Profit and Loss)

The income statement is calculated over a financial period; this might be a week, month or year. It doesn’t matter if a business is a limited company or self-employed; each year, a business has to produce annual accounts. The income statement is one of the main financial accounts.

Using the above example, the income statement would look like this:

How to use the figures on the Income Statement

The Income Statement of a business shows you the turnover, cost of goods (COGS) and all other costs. This allows you to understand how much profit was made during that period and the business’s financial health.

If you are running your own company, then it’s essential that you understand these figures so that you can make informed decisions about the selling price and how much profit is made. If the small business has a high gross profit but a low net profit, it will need to consider reducing costs or increasing the selling price.

Conclusion

In conclusion, understanding the differences between turnover, gross profit, and net profit is essential for small businesses. Turnover indicates the size and scope of a company, while gross profit and net profit provide insights into a business’s expenses and profitability.

As a small business owner, it’s critical to keep track of these metrics and use them to make informed financial decisions. Small businesses can grow and achieve their financial goals by effectively managing turnover, gross profit, and net profit. Understanding the Differences between Turnover, Gross Profit, and Net Profit for Small Businesses