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eRank does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors.
Profit is a word we are all familiar with, which means financial gain. All businesses strive for profit. You began your handmade business to make a profit. Did you know, though, that there are two types of profits – gross profit and net profit? As a business owner, it is important to understand the definition and application of both.
Have you used eRank’s Profit Calculator? Check it out to see if your items are priced for profit.
Gross Profit
Gross profit may also be referred to as gross income, and it is the profit type that most readily comes to mind. Gross profit is the money remaining from selling your handmade items and subtracting the material costs. It is important to evaluate the gross profit on each handmade item that you make and sell in order to ensure that you have priced your handmade item correctly.
Gross Profit = Sales – Material Costs
For example, you crochet a scarf and sell it on Etsy for $30. The yarn used to make the scarf costs $10. Your gross profit for the scarf is $20. If the scarf requires one hour of work to make, you make $20 for that hour’s work, which is not a bad rate. However, if the scarf requires four hours of work, you make $5 per hour, which tells you that the selling price is too low and needs to be adjusted.
Gross profit is important to evaluate when setting your prices for your handmade items. Gross profit, though, is only one part of the total financial picture of your handmade business.
Net Profit
Net profit, or net income, is an all-inclusive view of a business’s finances. Net profit is the amount remaining of earned income (sales) after all expenses related to your business are deducted. It shows you if your business is making a profit as a whole.
Net profit is your total sales minus your material costs (your gross profit) minus all operating expenses. Operating expenses include utilities, rent, subscriptions, bank fees, advertising, and postage, just to name a few.
If your business is not making a profit overall, the prices of your handmade items should be evaluated, as well as evaluating your operating expenses to see if any can be reduced. Sometimes, a handmade business may simply look at its gross profit and think that it is profitable. The whole picture of the business, though, should be analyzed. Net income is generally reviewed on a monthly or quarterly basis, not an item by item basis.
Net Profit = Sales – Material Costs – Operating Expenses
For example, in one month, the Etsy shop for your crochet business sells $1000 of product. Material costs are $300, resulting in a gross profit of $700. Depending on the amount of time involved to make the $1000 in products, it is most likely a good gross profit for your time.
When we look further, operating expenses to make the $1000 is $750 for the month. If we subtract the operating expenses from your $700 gross profit, this results in a net profit of -$50 or more correctly stated, a net loss of $50. As we can see, while the gross profit makes it appear as if your handmade business is doing well, the net profit shows you that you should look more closely at your product pricing and your expenses.
Which to Use
Both gross profit and net profit are important for a handmade business to review regularly, as both types allow you to evaluate your business at a different level. Gross profit is great to review regularly on an individual handmade item level to ensure that you are making the profit per item that you want and that your items are priced correctly.
Net profit allows you to look at your business as a whole. If your net profit is not the amount that you want, first evaluate your handmade item pricing. If you believe that your handmade items are priced correctly, allowing you to make the correct gross profit, review all your operating expenses and see if any can be reduced or eliminated.
Summary
Remember that owning a handmade business is about more than just the handmade items that you sell. You must understand your business’s numbers – gross profit and net profit – to ensure that your business is profitable for you. In the words of Idowu Koyenikan, “You have to work on the business first before it works for you.”
Michelle Badger, Accountant (25 + years) and Etsy seller