What is Profit?
Definition: Profit, also known as net income, is simply what is left behind when all expenses are deducted from earnings. It is also denoted as the financial benefit left behind whenever revenue exceeds expenses, costs, and taxes combined. In a business setting, profits can be channeled back into the business for expansion purposes or distributed among stakeholders.
The primary role of any business is to generate profits from the core business as business performance is measured in terms of profitability. For business owners, profit is simply the reward for investing in a business. In public companies, profits are normally channeled to investors in the form of dividends.
While some analysts are usually interested in top-line profitability, others pay close watch to profitability before deduction of taxes and other expenses. Other analysts pay close watch to what is left behind when all expenses are paid.
Types of Profit Formula Examples
The main three types of profit are gross profit, operating profit, and net profit. The trio appear in the income statement of companies and businesses, with each providing crucial information to the underlying performance over a given period.
Gross Profit
Gross profit is the first level of profitability. It is simply the difference between sales and cost of goods sold. It appears in the income statement and assesses the company’s efficiency in utilizing available resources to produce goods and services.
Gross profits take into account variable costs, which are costs that fluctuate depending on the units produced. It does not take into account fixed costs, which are costs that must be paid regardless of the units produced.
Gross profit formula
Gross Profit = revenue – Cost of goods sold
Company ABC generates $150,000 in sales on the sale of smartphones. The cost incurred in the production of smartphones is $60,000.
Gross profit, in this case, would be
Gross profit= $150,000 – $60,000 = $90,000
Gross profit margin =x 100= X 100= 60%
Operating Profit
Operating profit is simply the net revenues that a company or business makes from its core business functions. Interest and taxes are excluded in its calculation. Likewise, all profits earned from ancillary investments are excluded.
Conversely, operating profit acts as an accurate indicator of a business’s ability to generate profits from its core operations as it excludes all extraneous factors that might affect or influence profitability.
Operating Profit Formula
Operating Profit = Operating Revenue – Costs of Goods Sold – Operating Expenses – Depreciation – Amortization
Consider company XYZ that had $10,000 in operating expenses from the production of car spare parts. The total operating revenues generated from the sale of the spare parts totaled $ 30,000. Conversely operating profit would be
OP= $30,000- $10,000= $20,000
Operating Profit Margin = Operating Profit/ Total Sales = $20000/ $30,000= 66.7%
Net Profit
Net profit refers to the total profit left behind when all expenses, costs among other deductions are paid. Also known as net income or bottom line, net profit is calculated by adding all expenses and deducting from revenues. Similarly deducting taxes and interest from operating profits also results in net income.
Net Profit Formula
Total Revenue – Total Expenses = Net Profit
Net profit shows what the company has earned from its operations or the amount of loss incurred.
How to Increase Profits
Businesses and companies deploy a number of plays to improve profitability. One of the strategies deployed involves growing of revenues by increasing prices of goods and services. Likewise, a company can increase the products sold to customers. Rising prices with an increase in demand often leads to an increase in revenues.
While ramping up sales to increase revenues, firms also try to cut back on costs as a way of ensuring bumper profits. Cutting back on costs can help a business reduce the prices of goods in a bid to fuel demand and sale more items. Some of the options used to cut back on costs include laying off any redundant staff.
Summary
Profits are simply rewards left behind once all expenses are deducted from sales. The main objective of any business is to increase profits and stay clear of losses. Likewise, businesses and companies come up with new products and services to increase profits.