Gross profit, operating profit, and net profit are different measures of a company’s profitability. Gross profit is the profit a company makes after deducting the direct costs (cost of goods sold, or COGS) associated with producing goods or services, such as raw materials, direct labour, and manufacturing overhead. Operating profit is the profit a company makes after deducting both COGS and operating expenses such as rent, salaries, marketing, research and development, and depreciation. Net profit is the final profit a company makes after deducting all expenses including COGS, operating expenses, interest payments, and sometimes taxes.

Net profit represents a company’s “bottom line,” and it’s the most important measure of profitability. It shows how much money is left over for shareholders after the company has met all of its obligations. Below, we’ll explain the differences between net profit before taxes and net profit after taxes.

What’s in this article?

• What is net profit before tax?
  
• How to calculate net profit before tax
  
• What is net profit after tax?
  
• How to calculate net profit after tax
  
• How to manage taxes to maximise net profit
  

What is net profit before tax?

Net profit before tax (PBT)—also known as earnings before tax (EBT), or pre-tax profit – is a measure of a company’s profitability that shows how much profit it has generated before income taxes are deducted.

PBT is an important metric for several reasons:

• Comparison: It removes the impact of varying tax rates and allows for comparison of a company’s profitability across different tax jurisdictions.
  
• Performance analysis: It assesses a company’s core operational performance before the influence of tax policies.
  
• Tax impact: When compared with net profit after tax, PBT can show how much tax a company pays and its impact on overall profitability.
  

How to calculate net profit before tax

To calculate net profit before tax, subtract all expenses except for income taxes from a company’s revenue, including:

• Cost of goods sold (COGS): The direct costs of producing goods or services
  
• Operating expenses: Costs not directly tied to production, such as rent, salaries, and marketing
  
• Interest expenses: The cost of borrowing money
  

There are two main ways to calculate PBT:

• Formula 1: PBT = Operating Profit - Interest Expenses
  
• Formula 2: PBT = Total Revenue - Cost of Goods Sold - Operating Expenses - Interest Expenses
  

Sample calculation

If a company has $100,000 in total revenue, $50,000 in COGS, $20,000 in operating expenses, and $5,000 in interest expenses, its net profit before tax would be:

$100,000 Total Revenue - $50,000 COGS - $20,000 Operating Expenses - $5,000 Interest Expenses = $25,000 PBT

What is net profit after tax?

Net profit after tax (NPAT), also known as net income or the bottom line, is the final measure of a company’s profitability after all expenses have been deducted from revenue – including taxes.

NPAT is the most important measure of a company’s financial performance because it shows how much profit is available to be distributed to shareholders or reinvested in the business. A high NPAT indicates that a company is profitable and financially healthy.

Investors and analysts use NPAT to evaluate a company’s financial performance and make investment decisions. Lenders also use NPAT to assess a company’s credit.

How to calculate net profit after tax

To calculate NPAT, subtract all expenses from revenue including tax. The formula for calculating NPAT is:

NPAT = Total Revenue - COGS - Operating Expenses - Interest Expenses - Taxes

Sample calculation

If a company has $100,000 in total revenue, $50,000 in COGS, $20,000 in operating expenses, $5,000 in interest expenses, and $5,000 in taxes, its net profit after tax would be:

$100,000 Total Revenue - $50,000 COGS - $20,000 Operating Expenses - $5,000 Interest Expenses - $5,000 Taxes = $20,000 NPAT

How to manage taxes to maximize net profit

Companies can use the following strategies to reduce their tax obligations and maximise net profit.

Strategic entity structuring

• Choice of entity: The legal structure of your business (e.g., sole proprietorship, partnership, LLC, S corp, C corp) has important tax implications.

• Multiple entities: Consider using multiple entities for different business activities. This can help isolate risk and optimise tax benefits based on the nature of each activity.

• Hybrid entities: Explore hybrid structures that combine elements of different entities, such as a limited liability company (LLC) taxed as an S corp. This can offer the liability protection of an LLC with the tax advantages of an S corp.

Tax-advantaged investments

• Retirement accounts: Maximize contributions to tax-advantaged retirement accounts such as 401(k)s, individual retirement accounts (IRAs), or Simplified Employee Pension IRAs (SEP-IRAs) to defer income taxes and potentially lower your tax bracket.

• Health savings accounts (HSAs): If eligible, contribute to an HSA for tax-deductible healthcare expenses, with potential for tax-free growth and withdrawals for qualified medical costs.

• Municipal bonds: Consider investing in municipal bonds, which offer tax-exempt interest income.

Deduction strategies

• Accelerated depreciation: Use methods such as Section 179 deductions or bonus depreciation to write off the cost of assets more quickly, reducing taxable income in the near term.

• Research and development (R&D) tax credit: If your business engages in qualifying R&D activities, take advantage of the federal and potential state R&D tax credits.

• Cost segregation: With real estate investments, use cost segregation studies to reclassify property components for faster depreciation and potential tax savings.

International tax planning

• Foreign tax credits: If your business operates internationally, use foreign tax credits to offset US taxes on income earned abroad.

• Transfer pricing: For multinational companies, establish appropriate transfer pricing policies to allocate income and expenses among different entities in different tax jurisdictions.

Estate and gift tax planning

• Trusts: Use trusts to transfer assets and reduce estate and gift taxes. Different types of trusts have different tax benefits and control over assets.

• Annual gifts: Make use of annual gift tax exclusions to transfer funds to family members tax-free during your lifetime.

Tax loss harvesting

• Capital losses: Sell investments that have incurred losses to offset capital gains, reducing your overall tax liability.