The Difference in Net Income Gross Profit Vs. Contribution Margin

Net profit, gross income and contribution margin constitute figures used by accountants and business managers to assess the financial assets, profitability and spending capital of a company. Contribution margin and gross income bear intense similarities to one another but differ significantly in certain aspects. Net income relates to both of these terms but constitutes something very different. These terms require different mathematical formulas and variables to determine, and impact businesses in differing ways.

Calculating gross profit requires only the most basic math. Gross profit equals the costs of goods sold subtracted from the total sales revenue generate from those goods. This term applies most commonly to stores. For instance, assume a guitar store sells 100 guitars in a month, each at a cost of $500, for total sales of $50,000. If the store paid the manufacturer $350 for each guitar, it spent $35,000 total on the merchandise. The gross profit from this sale equals $15,000, or sales ($50,000) – cost of goods ($35,000). Calculating gross profit helps businesses determine the profitability of products.

Calculating net income proves slightly more complicated than calculating gross profit though still requires little more than basic math. Net income equals the actual profits generated after subtracting all expenditures. In the retail context, calculating net income requires subtracting a variety of values from the gross profit. For instance, assume a guitar store posts a monthly net profit of $15,000. Now assume that store paid its employees a total of $5000, paid a monthly rent of $3000 and spent $1500 on local advertising. The net income of the store equals $5500, or $15,000 - $5000 - $3000 - $1500. This example merely covers net income in retail. The term applies across the board to any business, which calculate net income by subtracting all expenditures from all revenue generated. Calculating net income gives a business a measure of its profitability and understand how it loses and gains capital.

Calculating contribution margin appears relatively simple on the surface but requires working with some unpredictable numbers. Basically, contribution margin constitutes the variable costs of a specific product subtracted from the sales generated from that product. Variable costs primarily include labor and materials. For instance, if a company sells 100 units of Product A in June and 250 units of Product A in July, that company spends more on labor and materials in July than in June but also generates more money. Manufacturers calculate contribution margin as a means of determining the profitability of labor and manufacturing processes and technology employed in product production.

The differences between contribution margin, net income and gross profit call into two camps, those between net income and the other two, and those between contribution margin and gross profit. On the surface, gross profit and contribution margin appear identical. The difference lies in the industry. Gross profit applies to the merchant industry, to situations in which companies purchase fully manufactured products and sell them. Contribution margin applies to the manufacturing industry, to situations in which a company produces and sells goods to the sales industry. Net income differs from both contribution margin and gross profit in scope. It concerns all the revenue generated by an entire company, while contribution margin and gross profit only concern sales and sales costs.