Gross profit vs net profit: definitions and worked example

Gross profit is your turnover minus the direct cost of what you sold. Net profit is what remains after you also take off overheads, interest and tax. Gross profit tells you whether your pricing works; net profit tells you whether the whole business makes money.

What is gross profit?

Gross profit is the money left from sales after paying the direct costs of producing or buying the goods or services you sold. The formula is:

Gross profit = turnover − cost of sales

Cost of sales (also called cost of goods sold) includes:

• stock bought for resale, adjusted for opening and closing stock
• raw materials and components
• direct labour, such as production staff or subcontractors on a job
• carriage and packaging to get goods to customers, if you treat it as a direct cost

Gross profit ignores rent, marketing, office salaries and other running costs.

What is net profit?

Net profit is the profit left after every cost of running the business, including interest and tax. Accountants often show it in stages:

1. Operating profit = gross profit − overheads (distribution costs and administrative expenses)
2. Profit before tax = operating profit + other income − interest payable
3. Profit after tax = profit before tax − Corporation Tax

“Net profit” usually means profit after tax for a company. For a sole trader, who pays Income Tax personally, it usually means profit before tax. Always check which figure someone means.

Gross profit vs net profit at a glance

The main difference is which costs each figure deducts.

Worked example: a small limited company

This example uses a limited company with £200,000 of sales in a year starting after 1 April 2026.

The margins follow from the table:

• Gross margin: £120,000 ÷ £200,000 = 60%
• Net margin before tax: £44,000 ÷ £200,000 = 22%
• Net margin after tax: £35,640 ÷ £200,000 = 17.8%

The tax line assumes taxable profit equals accounting profit and that the company has no associated companies. Profit of £44,000 is below the £50,000 limit, so the 19% small profits rate applies, according to GOV.UK’s Corporation Tax rates page. Use the profit margin calculator and the Corporation Tax calculator to run your own figures.

Where gross profit appears in UK accounts

UK company accounts show gross profit when they use Format 1 of the statutory profit and loss formats. Schedule 1 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 lists Format 1 in this order: turnover, cost of sales, gross profit or loss, distribution costs, administrative expenses, then other income, interest and tax. Small companies follow equivalent formats.

Format 2 classifies costs by type instead (materials, staff costs, depreciation), so it has no gross profit line. Most trading businesses use Format 1. Accounts are prepared under FRS 102, whose Periodic Review amendments take effect for periods starting on or after 1 January 2026.

Our guide on how to read a profit and loss statement walks through each line.

Why net profit is not taxable profit

Net profit in the accounts is the starting point for tax, not the final figure. HMRC’s Capital Allowances Manual at CA20006 says depreciation charged in the accounts “is not allowed as a deduction in computing taxable profits”, and capital allowances may be given instead.

Other common adjustments include:

• client entertaining, which is added back
• fines and penalties, which are added back
• capital allowances, which are deducted

Sole traders can deduct stock and raw materials as allowable expenses, as GOV.UK’s page on expenses if you’re self-employed confirms.

Which figure should you watch?

Which figure matters depends on the question you are asking.

• If your gross margin is falling, check supplier prices, discounts and wastage, or review your selling prices.
• If gross margin is healthy but net profit is thin, look at overheads such as rent, software and staff costs.
• If you are comparing yourself with competitors, compare gross margin with businesses in the same sector, since cost structures vary.
• If you are planning dividends, look at profit after tax and retained reserves, not gross profit.

A break-even calculation shows how many sales you need to cover overheads.

Frequently asked questions

What is the difference between gross profit and net profit?

Gross profit is sales minus the direct cost of those sales. Net profit is what is left after overheads, interest and tax are also deducted.

Is net profit before or after tax?

For companies it usually means profit after Corporation Tax. For sole traders it usually means profit before Income Tax, so check which is meant.

Is gross profit the same as turnover?

No. Turnover is total sales. Gross profit is turnover minus cost of sales.

Are wages included in cost of sales?

Wages of staff who make the product or deliver the service directly are usually in cost of sales. Office and management salaries are overheads.

Can gross profit be positive while net profit is negative?

Yes. If overheads, interest and tax are larger than gross profit, the business makes a net loss even though each sale covers its direct cost.