Although the two terms tend to be 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 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 Profitability
Profitability is closely related to profit – but with one key difference. While profit is an absolute amount, profitability is a relative one. 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. 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.
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 capital.
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 a profitability index to determine whether a project is worth pursuing. This metric provides company management with insight into the costs versus the 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.
The Bottom Line
Although they sound similar, profit and profitability are handled almost exclusively when it comes to investing and business management. Rearranging of product lines and increasing price are two theories that hold the most sway over whether a company has profit or can experience future profitability.