Gross Profit vs Net Profit: What the Numbers Mean

I had a catering client in Katy who was convinced she was doing well. Sales were up 30% from the year before. Her gross profit margin was holding at 68%. She called me in December to review her books before tax season.

We went through her income statement together. Her net profit for the year: $4,200 on $380,000 in revenue.

She almost fell out of her chair.

The gap between what a business earns on its products and what it actually keeps is where most Houston small business owners get blindsided. Gross profit and net profit are not the same thing. Confusing the two is how businesses end up cash-poor while looking successful on paper.

The Accounting Equation Behind the Two Numbers

Gross profit is the first profitability test. It answers one question: are you selling your product or service at a price that covers what it costs to produce?

Gross Profit = Revenue – Cost of Goods Sold (COGS)

COGS includes only direct costs: the ingredients you bought, the materials you used, the labor that went directly into producing what you sold. For a plumber in Spring Branch, COGS is pipe, fittings, and the hourly wages of the crew that did the job. For a restaurant, it’s food and beverage costs.

Net profit is the final answer. It tells you what the business actually kept after paying for everything.

Net Profit = Gross Profit – Operating Expenses – Interest – Taxes

Operating expenses are everything else: rent, utilities, insurance, office staff, marketing, accounting, vehicle costs, software subscriptions. These don’t go into COGS because they don’t change with each unit sold. You pay them whether you have one customer or a hundred.

Why the Gap Between Them Is the Number to Watch

The catering client’s numbers:

Line	Amount
Revenue	$380,000
Cost of goods sold (food, packaging, event labor)	$121,600
Gross profit	$258,400 (68%)
Rent + kitchen lease	$48,000
Administrative staff	$72,000
Vehicle and delivery costs	$31,000
Insurance	$14,400
Marketing and website	$18,000
Utilities and supplies	$22,000
Accounting and software	$8,800
Miscellaneous	$40,000
Net profit	$4,200 (1.1%)

Her gross margin was healthy. Her overhead ate 97% of it.

This is the trap. A strong gross margin tells you your pricing is right. It does not tell you your business is profitable. The moment you add rent, payroll for non-production staff, insurance, and all the other costs of running the operation, the picture changes completely.

The Gross Profit Margin by Industry

Before you can evaluate your numbers, you need to know what’s normal for your type of business. These are general benchmarks: your actual numbers will vary based on your specific market and operations.

Industry	Typical Gross Margin
Restaurants and food service	60–70%
Construction and contracting	20–35%
Retail (brick and mortar)	30–50%
Landscaping and lawn care	35–50%
Salons and beauty services	40–60%
Trucking and freight	15–25%
Consulting and professional services	60–80%

If your gross margin is below your industry average, the problem is in your pricing or your direct costs. You’re either charging too little or spending too much to deliver the product.

If your gross margin is on target but your net margin is low or negative, the problem is overhead. You have a pricing model that works, but a cost structure that’s too heavy for your revenue level.

A Tale of Two Houston Contractors

Two general contractors in the Houston area. Both doing about $1.2 million in annual revenue. Similar type of work. Very different outcomes.

Contractor A (Heights area):

• Revenue: $1,200,000
• COGS (materials, subcontractors, field labor): $780,000
• Gross profit: $420,000 (35%)
• Office staff, insurance, equipment, truck payments, marketing: $310,000
• Net profit: $110,000 (9.2%)

Contractor B (Humble area):

• Revenue: $1,200,000
• COGS: $900,000
• Gross profit: $300,000 (25%)
• Same overhead category: $295,000
• Net profit: $5,000 (0.4%)

Contractor B had a COGS problem. He was buying materials without tracking supplier pricing, letting crew time bleed on jobs, and underbidding because he never calculated his true cost to deliver. His gross margin was 10 points below a healthy benchmark for his trade.

He was working $1.2 million worth of work to take home $5,000. At that point, he would have been financially better off closing the business and getting a job.

Fixing Contractor B’s problem required renegotiating supplier terms, tightening job costing, and repricing certain project types. Once his COGS came down, his gross margin moved to 31%: still below A, but enough to generate meaningful net profit.

What to Look At Every Month

You do not need to be a CPA to use these two numbers. You need to look at your income statement every month and track four things:

1. Is gross margin stable or shrinking? If your gross margin was 45% in January and it’s 38% in June, something changed: supplier costs went up, you discounted more, or your labor got less efficient. Find it before it gets worse.

2. Is net margin positive? The minimum acceptable net margin for most small businesses is 5%. Below that, you are not generating enough return to justify the risk of running a business. Below zero, you are depleting the reserves you started with.

3. What is eating the gap between gross and net? Pull out each operating expense line and look for what grew as a percentage of revenue. Rent is usually fixed, so if it’s a higher percentage this month, it means revenue fell. Payroll creeping up often means you added staff ahead of revenue.

4. Which revenue streams have the best gross margin? Most businesses sell more than one thing. A landscaping company might do residential lawn maintenance, commercial contracts, and seasonal cleanups. Each has a different cost structure. Knowing which line is most profitable tells you where to focus sales effort.

The Fix Is Different Depending on the Problem

If gross profit is low, your fix is in the product:

• Raise prices
• Reduce direct material costs (renegotiate, buy in bulk, change suppliers)
• Improve labor efficiency on production

If net profit is low but gross profit is healthy, your fix is in the overhead:

• Cut or renegotiate fixed costs (rent, insurance, software subscriptions)
• Evaluate whether support staff headcount is justified by revenue
• Find out which expenses grew without a corresponding revenue increase

The income statement gives you the data. Your job is to look at it every month, not just at tax time.

What This Means Before You Borrow

Lenders look at net profit, not gross profit, when they evaluate your ability to repay a loan. A business with $200,000 gross profit and $195,000 in overhead does not have the cash flow to support debt service: regardless of what the top-line revenue looks like.

If you are planning to apply for a business line of credit or SBA loan in the next 12 months, your net profit margin needs to be showing strength. That means starting to work on overhead and cost structure now, not the month before you apply.

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If you are looking at your income statement and not sure what story the numbers are telling you, describe your problem and we can take a look together.

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