What is net profit?
Published
Net profit is what remains of revenue after all costs and expenses: cost of sales, operating expenses, finance costs, and any other items. It is the bottom line of the income statement.
The equations
Net profit = Revenue − COGS − Operating expenses − Finance costs − ZakatNet margin = Net profit ÷ RevenueReturn on equity = Net profit ÷ Average equityEBITDA = Operating profit + Depreciation and amortisation
Al-Waha's figures
Net profit before zakat = SAR 27,250Net margin = 27,250 ÷ 460,000 = 5.9%EBITDA = 31,250 + 5,750 = SAR 37,000 (8.0% of revenue)Return on equity (quarterly) = 27,250 ÷ ((350,000 + 359,250) ÷ 2) = 7.7%
Three things net profit is not
This is the core of the page, because confusion here produces bad decisions.
1. Net profit is not cash. Al-Waha earned SAR 27,250 and its bank balance fell SAR 9,000 in the same quarter. The difference went into receivables, inventory, drawings, and equipment.
Free cash flow = SAR 9,000Net profit = SAR 27,250Actual drawings = SAR 18,000
The safe withdrawal figure is far closer to free cash flow (9,000) than to net profit (27,250). An owner drawing at the level of accounting profit is taking cash the operation needs.
3. Net profit is not the zakat base. The zakat base is computed under ZATCA's rules, starting from equity and added funding sources with fixed assets and long-term investments deducted - not directly from the net profit figure. The two numbers are different by construction.
Net profit vs. operating profit vs. EBITDA
| Al-Waha | Measures | Ignores | |
|---|---|---|---|
| Gross profit | 192,000 | Pricing and purchasing | All expenses |
| Operating profit | 31,250 | Operational efficiency | Financing and tax |
| EBITDA | 37,000 | Rough operating cash generation | Depreciation, financing, working capital |
| Net profit | 27,250 | The final result | Nothing |
When is EBITDA useful? Comparing businesses with different financing or asset structures, or in valuation for a sale. When does it mislead? When used as a proxy for cash flow. Al-Waha's EBITDA is SAR 37,000 and its free cash flow is SAR 9,000. The SAR 28,000 difference sits in working capital movements and capital expenditure - both very real.
Errors that distort net profit
| Error | Effect on Al-Waha |
|---|---|
| Booking owner's drawings as an expense | Net profit of 9,250 instead of 27,250; margin of 2.0% instead of 5.9% |
| Recording collected VAT as revenue | Net profit of 96,250 instead of 27,250 |
| Ignoring depreciation | Net profit of 33,000 instead of 27,250, and assets that never decline in the books |
| Ignoring the end-of-service provision | Net profit overstated by 5,400, with a hidden liability accruing |
Frequently asked questions
What is a good net margin?
It varies widely by sector. Retail and wholesale at 3-8% is normal; services and consulting can reach 15-25%; software higher. What matters more is the trend across periods than the figure in any single one.
What is the difference between net profit and retained earnings?
Net profit is the result of one period. Retained earnings accumulate every profit since inception, less every drawing and distribution. For Al-Waha: 150,000 + 27,250 − 18,000 = 159,250.
Does a loss mean the business is failing?
Not necessarily, particularly in start-up or expansion years. The more dangerous signal is a continuing loss alongside negative operating cash flow - at that point the business is consuming its capital.
Why does my accounting profit not match my sense of how the business is doing?
Usually because your instinct is anchored to the bank balance, a cash measure, while profit is an accrual measure. Or because real costs are unrecorded: depreciation, end-of-service provision, or bad debts.