What is Net Profit?

Published by Thomas Herold in Accounting, Corporate Finance, Economics, Investments

The term 'Net Profit' is included in the Accounting edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Net Profit refers to the remaining sales dollars which are left over after a firm pays for all of its operating costs, interest on debt, preferred stock dividends, and taxes. Common stock dividends are not included in the amounts deducted from the firm’s aggregate sales revenue. Sometimes analysts call this type of profit the net income, the bottom line, and/or the net earnings.

A simplistic (but useful) way of thinking about this form of profit is that it is all of the money which remains after all of the expenses of the going concern are paid in full. Calculating the net income is done when aggregate expenses are subtracted from total revenue. Because these net earnings traditionally occur on the final line in an income statement, companies often refer to it as their “bottom line.”

It remains true that this Net Profit is still among the most closely watched business indicators in the world of finance. Because of this, it has a substantial part in the computations of financial statement analysis and ratio analysis. Stake holders in the corporations also scrutinize this bottom line carefully since it ultimately proves to be the way they become compensated as shareholders in the firm. When corporations are unable to realize enough profits to pay their shareholders, stock prices plunge. On the other hand, when corporations are growing and in solid financial health, the more available profits become reflected in greater stock prices.

A common mistake that many individuals make is in their understanding of what net profits actually represent. Net profit is never the metric for the total cash earnings a firm realized in a certain period. The reason for this confusing fact is that income statements also showcase a range of expenses that are not cash-based. Some of these are amortization and depreciation. In order to understand the true amount of cash which corporations actually generate, investors and analysts must carefully review the cash flow statement.

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In fact any changes to net profit will be constantly and thoroughly reviewed, examined, and discussed. When firms’ net profits are negative or even lower than anticipated, there are a host of issues that could be causing it. It might be that the customers’ experience is negative. Sales could be decreasing for one or more reasons. Expenses at the company could be out of control or simply poorly managed and monitored. New management teams may not be performing at the anticipated or promised levels.

In the end, the Net Profit will range wildly from one firm to the next and according to which industry they represent. One industry’s profits will likely be substantially different from another industry’s. It is not a useful comparison to make between one corporation and another since these profits are quantified in dollars (Euros, pounds, Swiss francs, or yen). It is also a fact that no two corporations will be exactly the same size by either revenues or assets.

This is why many analysts prefer to make comparisons between corporations and industries by utilizing what they call profit margin. This is the net profit of a company as a percentage amount of its total sales. Sometimes analysts and investors will also look at the P/E Price to Earnings Ratio alternatively. This widely cherished ratio reveals to considering investors what the price is (in the form of stock price) for every dollar of net profit the corporation actually generates.

Analysts still like the metric of net profit despite these limitations. A survey conducted querying around 200 marketing managers who were senior level revealed that an incredible 91 percent agreed that they believe this measurement to be very useful.

The term 'Net Profit' is included in the Accounting edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.