Loading the player...
A:

Although the two terms are used interchangeably, profit and profitability are not the same. Both can be used as accounting metrics in analyzing the financial success of a company, but there are distinct differences between the two. To adequately determine whether a company is financially sound or poised for growth, investors must first understand what differentiates a company’s profit from its profitability.

Definition of a Company's Profit

Profit is an absolute number determined by the amount of income or revenue above and beyond the costs or expenses a company incurs. It is calculated as total revenue minus total expenses and appears on a company's income statement. No matter the size or scope of the business or the industry in which it operates, a company's objective is always to make a profit.

Definition of a Company's Profitability

Profitability is closely related to profit, but it is the metric used to determine the scope of a company's profit in relation to the size of the business. Profitability is a measurement of efficiency – and ultimately its success or failure. It is expressed as a relative, not an absolute, amount. Profitability can further be defined as the ability of a business to produce a return on an investment based on its resources in comparison with an alternative investment. Although a company can realize a profit, this does not necessarily mean that the company is profitable.

Important Uses

To determine the worth of an investment in a company, investors cannot rely on a profit calculation alone. Instead, an analysis of a company’s profitability is necessary to understand if the company is efficiently utilizing its resources and its initial investment.

If a company is deemed to have a profit but is unprofitable, there are a number of tools that can be used to increase profitability and overall company growth. A company can be quickly bogged down with failing projects, which directly leads to sunk costs. To reduce the occurrence of project failures, companies can explore the profitability index to determine whether a project is worth pursuing. This metric provides company management with insight into costs versus benefits of a project, and it is calculated by dividing the present value of future cash flows by a project's initial investment.

A company can also increase profitability through the theory of marginal returns. One of the first steps a company takes to increase profitability is to boost sales, which requires an increase in production. Marginal return, also known as marginal product, is a theory that states that the addition of workers up to a certain point increases the use of capital in an efficient way; exceeding that number of workers leads to diminishing returns and ultimately less profitability. In order to be profitable, it is necessary for a company to apply this theory to its specific business and production needs to experience growth in an efficient, cost-effective manner.

RELATED FAQS
  1. What is the difference between gross profit margin and operating profit margin?

    Understand the difference between gross profit margin and operating profit margin, two measures of corporate profitability ... Read Answer >>
  2. What is the difference between gross profit margin and contribution margin?

    Learn the difference between gross profit margin, an overall profitability metric analysts use, and contribution margin, ... Read Answer >>
  3. What is the difference between gross profit margin and net profit margin?

    Gross profit margin and net profit margin are two separate profitability ratios used to assess a company's financial stability ... Read Answer >>
  4. What is the difference between gross margin and profit margin?

    Understand the difference between gross margin and profit margin, and learn about the profitability ratios used in evaluating ... Read Answer >>
  5. Is net income the same as profit?

    Understand the difference between profit and net income, including why corporate accountants calculate profit at different ... Read Answer >>
  6. How is gross profit margin used in sales?

    Learn and understand the meaning and usefulness of the gross profit margin figure for a company in relation to its total ... Read Answer >>
Related Articles
  1. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  2. Investing

    Understanding Profit Metrics: Gross, Operating and Net Profits

    Rather than relying solely on a company's net profit figures, seasoned investors will often look at gross profit and operating profit as well.
  3. Investing

    4 Tips to Evaluate Growth Companies (KO, AAPL)

    Discover the best metrics for stock investors to utilize when selecting and evaluating the best opportunities in growth investing.
  4. Investing

    Gross, Operating and Net Profit Margins

    A company’s income statement includes the company’s gross, operating and net profits.
  5. Investing

    Interpreting a Strategy Performance Report

    A strategy performance report can provide key metrics to decide if your strategy is a winner.
  6. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
RELATED TERMS
  1. Profit

    A financial benefit that is realized when the amount of revenue ...
  2. Profit Margin

    Profit margin is a profitability ratios calculated as net income ...
  3. Operating Profit

    Operating profit is the profit earned from a firm's normal core ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the ...
  5. Corporate Profit

    Corporate profit is the money left over after a corporation pays ...
  6. Accounting Profit

    A company's total earnings, calculated according to Generally ...
Hot Definitions
  1. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  2. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  3. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  4. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  5. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
Trading Center