Gross Profit vs Operating Profit vs Net Profit

A profit and loss statement reports profit three times, and the three figures answer three different questions. Gross profit asks whether the product makes money. Operating profit asks whether the business makes money. Net profit asks whether the shareholders make money.

Confusing them is how companies conclude they have a pricing problem when they have an overhead problem.

The ladder

Each level removes one more layer of cost:

Revenue
  − Cost of sales                        → Gross profit
  − Selling and administrative expenses  → Operating profit
  ± Other and financial results
  − Income tax                           → Net profit

Using the income statement from this series, in euros:

Level	Amount	Margin
Sales revenue	180,000	—
Cost of sales	−104,000
Gross profit	76,000	42.2%
Selling expenses	−21,000
Administrative expenses	−43,800
Operating profit	11,200	6.2%
Other activity result	+600
Financial activity result	−600
Profit before tax	11,200	6.2%
Income tax	−1,800
Net profit	9,400	5.2%

Each margin is the level divided by revenue. Three numbers, three diagnoses.

Gross profit — does the product work?

Gross profit = revenue − cost of sales.

Cost of sales is the cost of the specific things sold: purchase or production cost of the goods, direct labour, direct production overheads. It scales with volume — sell twice as much and it roughly doubles.

Gross margin is the most fundamental number in the business, because it sets the ceiling on everything else. A 42.2% gross margin means every 100 € of sales leaves 42.20 € to cover all overheads and still profit. If overheads run at 36 € per 100 € of sales — as they do here — the business works. If gross margin falls to 30%, no amount of overhead discipline saves it.

When gross margin moves, the cause is always one of four things: selling prices, input costs, product mix, or how much is being given away in discounts. It is never "the office is too expensive".

The classification trap. Whether a cost sits in cost of sales or in administration changes gross margin without changing net profit by a cent. Production supervisors' salaries, delivery costs, warehouse rent — all defensible in either place. What matters is choosing once and never quietly moving it, because a gross margin that improved because a cost was reclassified is a lie the company tells itself. This is also why cross-company gross-margin comparisons need care.

Operating profit — does the business work?

Operating profit = gross profit − selling and administrative expenses.

Now the overheads come out: salaries not directly attributable to production, rent, software, marketing, depreciation, professional fees. These are period costs — they attach to the calendar, not to units sold, and they largely continue whether the company sells anything or not.

Operating profit is the cleanest measure of the trade itself, because it stops before financing and tax. Two companies with identical operations, one debt-free and one heavily borrowed, show the same operating profit and very different net profits. That is exactly what the level is for — it lets you judge the business separately from how it was funded and where it is taxed.

It is also the level management actually controls. Interest rates and tax law are given; the gap between gross and operating profit is a set of decisions.

Where EBITDA fits. EBITDA — earnings before interest, tax, depreciation and amortization — is operating profit with depreciation and amortization added back. It is popular because it approximates operating cash generation and strips out how aggressively a company depreciates its assets. It is dangerous for the same reason: depreciation is a real cost, just paid earlier, and a business valued on EBITDA can look wonderful while quietly consuming the equipment it depends on. It is a useful cross-company comparison, not a substitute for either operating profit or the cash flow statement.

Net profit — what actually belongs to the owners

Net profit = profit before tax − income tax, after other and financial results.

Everything is in now: interest paid to lenders, FX differences, gains and losses on asset disposals, and corporate income tax. What remains is the shareholders' return — the amount that increases equity and becomes available (subject to legal limits) for distribution. It flows straight into retained earnings.

Two properties surprise people. First, net profit is the most volatile of the three: a single asset sale or FX swing can move it substantially while the business underneath is unchanged. Second, tax rarely equals the headline rate times profit before tax — 1,800 € on 11,200 € here is 16.1%, not Lithuania's 17%, because tax is computed on taxable profit, which differs from accounting profit through non-deductible expenses, reliefs and timing differences.

Reading the three together

The diagnosis is in which margin moved:

Symptom	Likely cause
Gross margin down, operating margin down by the same	Pricing, input costs, or discounting
Gross margin flat, operating margin down	Overheads growing faster than sales
Operating margin flat, net margin down	Financing costs, FX, or tax
All three up, cash falling	Growth consuming working capital — check receivables and stock

That last row is the one worth memorizing. Rising margins with falling cash is not a contradiction; it is the standard profile of a growing company financing its customers, and profit alone will never reveal it.

How the subtotals are produced

In Nordlet these are not manual groupings. POST /v1/reports/financial-statements returns the profit-and-loss detail with each level already computed — sales revenue, cost of sales, gross profit, selling expenses, administrative expenses, operating profit, other and financial activity results, profit before tax, income tax and net profit.

The mapping runs off the chart of accounts: in the standard Lithuanian chart, revenue comes from account group 50, cost of sales from 60, selling expenses from 61, administration from 62, financial items from 53/58 and 68, and income tax from 69. Two practical consequences: posting a cost to the right account is what makes the subtotals meaningful, and a customized chart deserves one check against the statement before its margins are trusted. Because everything derives from the general ledger, each figure decomposes back to the individual journal entries that produced it.

FAQ

What is the difference between gross profit and net profit?

Gross profit deducts only the cost of what was sold and measures whether the product itself is profitable. Net profit deducts everything else as well — overheads, financing, tax — and measures what is left for the owners. Gross profit sets the ceiling; net profit is the result.

Is operating profit the same as EBIT?

Effectively yes in most presentations — EBIT (earnings before interest and tax) and operating profit both stop before financing and tax. Small differences appear in how "other" operating items are treated, so a company comparing itself to peers should check what each includes.

Why is EBITDA not the same as cash flow?

Because it ignores working-capital movements, capital expenditure, tax and interest actually paid. It adds back depreciation as though the asset were free, when in fact the cash left when the asset was bought. Use it as a comparison metric; use the cash flow statement to know what happened to money.

Can a company have positive gross profit and negative net profit?

Routinely — it is the most common shape of loss. The products make money, but overheads, interest or tax consume more than the gross profit covers. The fix is a different one from a gross-margin problem, which is why the levels are reported separately.

Why doesn't income tax equal the tax rate times profit before tax?

Because tax is charged on taxable profit, not accounting profit. Non-deductible expenses, tax reliefs, loss carry-forwards and timing differences all drive a wedge between the two, so the effective rate almost always differs from the statutory rate.