All publicly-traded companies maintain financial records that can assist investors in determining whether or not they wish to invest their hard-earned dollars in corporate stock. Two of the most influential data points on a company's income statement are its gross profits and its net income. Both of these metrics convey different elements of a company’s fiscal health and should each be thoughtfully considered by prospective investors. This article breaks down the characteristics of these key fiscal measurements.
- Gross profit refers to a company's profits earned after subtracting the costs of producing and distributing its products.
- Net income indicates a company's profit after all of its expenses have been deducted from revenues.
- Net income is often referred to as the "bottom line," due to its positioning at the bottom of income statements.
Simply stated, gross profit is a company's profits earned after subtracting the costs of producing and selling its products. The gross profit is calculated using the following formula:
Gross profit = Revenue - Cost of Goods Sold
Revenue is the total amount of money earned by a company for a given reporting period. Revenue is sometimes listed as net sales because it may include discounts and deductions from returned or damaged merchandise. Revenue is often referred to as the “top line“ number because this figure is situated at the top of the income statement.
Cost of goods sold (COGS) refers to the direct costs involved with producing goods, including the following items:
- Direct materials
- Direct labor
- Equipment costs used in production
- Repair expenses
- Utilities for production facilities
- Shipping costs
Net Income is a figure detailing a company's profits, also known as its earnings. Net income is often referred to as the bottom line, due to its positioning at the bottom of income statements. Investors should be mindful of the following points:
- Net income is the profit after all expenses have been deducted from revenues, including interest on loans, general and administrative costs, income taxes, depreciation, and operating expenses such as rent, utilities, and payroll expenditures.
- Net income includes additional income streams such as interest on investments or proceeds from the sale of assets.
Contrasting Gross Profit And Net Income
Example: Comparing Gross Profit and Net Income
J.C. Penney Company Inc. (JCP)
The following income statement was reported by retail giant J.C. Penney for 2017, on its 10K annual statement:
- Revenue and Net Sales: $12.50 billion.
- Gross Profit: $4.33 billion or (total revenue of $12.50 billion - COGS of $8.17 billion).
- Net income: A $116 million loss.
The Bottom Line
Although J.C. Penney earned $4.33 billion in gross profits that year, after deducting the remaining expenses, including selling, general, and administrative (SG&A) costs, plus the interest cost of its debt, the company actually suffered a $116 million loss. This real-life example demonstrates why it is critical to analyze a company's financial statements using multiple metrics, to accurately determine whether the company is performing well, or if it's suffering losses.