What Does It Mean If You Have a Lot of Gross Profit But Very Little Net Income?
A company calculates gross profit by subtracting its cost to manufacture or purchase products from the revenue it gains by selling the products to its customers. Several additional steps are necessary before the company can calculate net income. These steps involve calculating the costs that are not needed to make or buy the product and the company's tax bill. If these costs are high, the company will report a high gross profit and a low net income.
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Gross profit is always higher than net income. Since net income does not include the salaries of managers, clerical workers, sales agents, and other support staff, their salaries reduce the company's total income. According to Vanderbilt University, a standard corporation pays taxes at a 35 percent rate. Even if the corporation claims some deductions, it normally must pay some taxes.
Overhead
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Gross profit includes some overhead costs, but not others. The company includes its rent and power bills for the factory it uses to make the items when it calculates the cost of goods sold, which is subtracted from total revenue to find gross profit. The company must also pay rent and power bills for its office buildings, which are expenses that are not necessary to actually make its products.
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Importing
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A company can also have a high gross profit by purchasing items and selling them at a steep markup. For a retailer, the cost of goods sold is the cost to purchase inventory from a vendor, since the retailer doesn't manufacture its products. A retailer can import products at low prices from a country that manufactures them cheaply, and then sell the products for a much higher price. The cost to buy these cheap goods will be much lower than the wages the company pays to marketers and its clerical staff.
Other Losses
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The company's other gains and losses affect its net income. The company may sell an office it no longer needs, or collect income from selling stocks it owns. If a manufacturer or a retailer earns income from financial activities and real estate sales, it reports these gains separately from the income it makes by selling its products. If the company loses money on these transactions, this can produce a low net income when the company earns a high gross profit.
Taxes
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Taxes may be the main cause of the lower income. If the company's gross income is $1,200,000, and its non-manufacturing expenses are $200,000, the company earns $1,000,000 before taxes. A company that earns $1,000,000 in income after paying its non-manufacturing expenses pays $350,000 in taxes without including the effect of other deductions, leaving it with $650,000 in after-tax income.
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References
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