In recent issues, we’ve tackled a handful of intense, meaty topics:

That’s… a lot. 

So, this week, we’re talking about a straightforward business fundamental that (hopefully) doesn’t hip-check you in front of an existential crisis bus about your business or life:

Gross profit vs. net profit.

It’s easy to feel badly about your business this time of year

My second year in business, I received an email from a consultant with a comparable business, crowing over her achievement of earning $800,000. I was crushed. But then I learned the real story -- she spent over $1 million to generate that revenue, and hadn’t paid herself. Hmm. 

When you hear people bragging about how much they “earned” last year, you might worry: 

“Oh my gosh, they’re doing so well, and I’m not. What do they know that I don’t? What am I doing wrong? Am I a failure?”

Sure, they might have had a good year. (And since we’re good humans, we don’t root for others to fail just so we can feel better about ourselves.)

But when we tell the “success stories” of our businesses, we usually focus exclusively on the headline number: all the money that came in the door. Then we enthusiastically (and incorrectly) label that pile of cash “profit,” like we’re the Underpants Gnomes in South Park:

When you see those big numbers, it’s fair to ask -- did you just collect underpants, or did you actually profit? 

People take liberties with accounting words. “Earned” in accounting means income -- the net amount after all the expenses are paid. Often, people use “earned” as a proxy for revenue, or the gross amount they collected. And there’s a bunch of other stuff we can’t know from a word like “earned.” Perhaps they piled up credit card debt, skipped health insurance, or didn’t pay themselves. 

So where are the PR liberties, and what should you actually care about? 

This is where knowing the difference between gross profit and net profit matters. 

Gross profit is the money you collected (revenue) minus the costs that it took to deliver that product or service. 

For example, if you pay me $100 for a service, but I have to pay someone else $60 to successfully deliver that service, my gross profit would be $40. This is also called gross margin. My gross margin in this case would be 40%.

We also call this amount “above the line.”

If you run a product-based business, your above-the-line costs can take a pretty big chunk out of your revenue. Let’s say you charge $22 for one of those cute smooshy lights that the kids love right now. You pay your manufacturer $8 for that light, plus onshoring, customs and tariffs, and perhaps free shipping out to the buyer. 

That $22 gets whittled down quickly. 

Why does it matter? Knowing your gross profit determines how much money you have left to operate the business, cover any borrowing costs, and pay yourself. Every unit you sell contributes some amount to the rest of your expenses.

If you ask me, “Can I afford to spend X or Y?” my first look is to your gross profit. Does the investment help you sell more stuff, more efficiently? Or does the investment have to come out of the money left after we pay for everything else? 

You have other stuff to pay for: software, licenses, rent, taxes, wages, and so on. These are the general administrative expenses that support the functions of your business, but do not specifically go toward delivering a product or service to a customer.

Your net profit is the number that remains after those are subtracted from your gross profit. 

This is where we get real in your business. 

For example, in December, I did a net profit test with each of my clients by running a test close. In one case, we initially had about 20% net profits. Amazing, right? But then we factored in the owner’s retirement savings, incentive compensation due to the team for generating those great profits, and some investments we’d need to make for 2026. 

Were we mad? Not at all. We made smart, timely investments. 

Net profit is also what you pay taxes on -- meaning this is the number we play with if we do or don’t want to have taxable income. 

We want healthy gross profits. Frankly, in most cases, I don’t care that much about your net profit as long as we ended up there on purpose. I care that you make enough money from every sale to pay for the growth, operations, and compensation you want.

Early on, you’re probably more concerned about using your financial reports to get all of your tax deductions. Gross and net profit may not matter that much to you right now, because you threw a number out for your products or services to see what would work in the market. 

And that’s OK! We all start somewhere. 

As you grow, though, that collection of line items won’t tell you anything useful about how your business is functioning. Once you have to start paying for other people and real expenses, your gross and net will start to matter a lot. 

So, go forth and use this knowledge well. Is it time to level up from just saving money on your taxes to knowing things that will help you run your business better?

OK, enough accounting talk. Here are your next steps:

Have more questions? Book a free 20-minute strategy session.

Interest rates. The Fed held interest rates steady last week. And the president nominated a not-insane new Fed chair with a historical bias toward controlling inflation. As a result, the dollar is stabilizing and prices of precious metals have fallen. May Kevin with the Good Hair remain an economist without becoming a sycophant.

The government shutdown. January jobs number and Q1 economic performance reports are on ice due to another government shutdown. Here’s to hoping we get some actual results out of this one.

Software stocks. As we all evaluate our SaaS subscriptions, the market is also pummeling those software companies with features that can be readily replicated by AI. I’m keeping an eye on private equity-owned software companies that are central to my clients’ operations.

Polycrisis fatigue. I had lunch with a longtime newsletter reader last week, and we got to talking about the added complexity of making decisions in waves hand all of this. You cannot read all of the news and solve all the problems, all of the time. Collectively, we can. 

ICYMI, here are resources you should know about:

Mr. Beast is worth $2.6B, but he has to borrow cash and can’t “afford” McDonald’s. Here’s a real-world example of why knowing the difference between gross and net matters. Sure, Mr. Beast is worth an insane amount of money on paper - - but he’s cash poor. His teeny candy bars have mad gross margins, yo. And he also employs most of a city in North Carolina. Flashy opportunities like his shows and omnipresent retail hide the fact that the payment terms mean you often get paid last.

Love it or hate it, Southwest has said goodbye to open seating… and it’s complicated. Once famous (or infamous) for its unassigned seating and group boarding cattle calls, Southwest has gone mainstream with assigned seats. Of course, frequent fliers and others willing to fork over cash for extra legroom can buy their way into priority boarding groups, just like other airlines. SWA projects this added complexity will be worth it, to the tune of $1.5B. Industry analysts predict more delays and a drop in customer satisfaction. One sad customer: my kiddo, who loves picking our spot.