A:

The terms "profit" and "income" are often used interchangeably in day-to-day life. In corporate finance, however, these terms can have very different and specific meanings, depending on the context in which they are used.

While income does mean positive flow of cash into a business, net income is something much more complex. Profit is generally understood to refer to the cash that is left over after accounting for expenses. Though both gross profit and operating profit fit this definition in the simplest sense, the kinds of income and expenses that are accounted for differ in important ways.

Perhaps the simplest way to understand these three concepts – gross profit, operating profit and net income – and how they relate to each other is to look at them in the order they appear on a company's income statement. The top line of the income statement reflects a company's gross revenue, or the total amount of income generated by the sale of goods or services. From there, various expenses and alternate income streams are added and subtracted to arrive at different levels of profit.

What Is Gross Profit?

Gross profit is the total revenue less only those expenses directly related to the production of goods for sale, called the cost of goods sold (COGS). These include expenses for raw materials and the labor to build or assemble a product but exclude other wages and overhead expenses, such as rent.

Gross profit = Revenue - Cost of Goods Sold

The result is a profit metric that reflects the amount of money left over to fund the business after accounting for the cost of simply producing a product. While gross profit is technically a net measurement of profit, it is referred to as gross because it does not take debts, taxes, interest or operating expenses into account.

What Is Operating Profit?

Next on the income statement is operating profit. Derived from gross profit, operating profit reflects the residual income that remains after accounting for all the costs of doing business. In addition to COGS, this includes fixed-cost expenses such as rent and insurance, variable-cost expenses such as shipping and freight, payroll and utilities, as well as amortization and depreciation of assets. All the expenses that are necessary to keep the business running must be included.

Operating Profit = Operating Revenue - COGS - Operating Expenses - Depreciation and Amortization

However, like gross profit, operating profit does not account for the cost of interest payments on debts, additional income from investments or taxes. Gross profit reflects the profitability of a company's operations.

What Is Net Profit?

Finally, net income, also called net profit, is the infamous bottom line. This reflects the total residual income that remains after accounting for all cash flows, both positive and negative. From the operating profit figure is subtracted all debt expenses such as loan interest, taxes and one-time entries for unusual expenses such as lawsuits or equipment purchases. All additional income from secondary operations or investments and one-time payments for things such as the sale of assets are added.

The result is arguably the most important financial metric of them all, reflecting a company's ability to generate profit for owners and shareholders alike.

RELATED FAQS
  1. 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 >>
  2. How do operating income and net income differ?

    Operating income and net income both show the income earned by a company, but they are distinctly different ways of expressing ... Read Answer >>
  3. Does gross profit include labor and overhead?

    Gross profit is a company's profit after subtracting the costs of producing the goods and services. Several costs impact ... Read Answer >>
  4. What is the difference between revenue and profit?

    Revenue is the total amount of income generated by a company. Profit is the bottom line or net income after accounting for ... Read Answer >>
  5. What is the formula for calculating gross profit margin in Excel?

    Understand the basics of the gross profit margin including its interpretation as a measure of profitability and its calculation ... Read Answer >>
  6. What is considered a healthy operating profit margin?

    An operating profit margin is a profitability ratio that investors use when evaluating a company. Comparing a company's margins ... 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 the Income Statement

    The best way to analyze a company - and figure out if it's worth investing in - is to know how to dissect its income statement. Here's how to do it.
  3. Investing

    Profitability Indicator Ratios

    Learn about profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed.
  4. Investing

    Calculating Economic Profit

    Economic profit is the difference between the revenue a firm earns from sales and the firm’s total opportunity costs.
  5. Investing

    Interpreting a Strategy Performance Report

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

    The Gross Margin

    A business's "gross margin" is a rough gauge of how profitable its operations are. It measures how much sales revenue the company retains after all of the direct costs associated with making ...
  7. Managing Wealth

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  8. Investing

    Calculating Net Income

    Otherwise known as the "bottom line", net income is the most commonly used indicator of a company's profitability. Learn more about how it an investor's decision to own or sell a stock.
  9. Investing

    How To Analyze Netflix's Income Statements

    Learn how to read Netflix's income statement, calculate net income and interpret EPS to evaluate the company's current financial condition.
RELATED TERMS
  1. Accounting Profit

    Accounting profit is a company's total earnings, calculated according ...
  2. Gross Income

    Gross income is the total income from all sources before deductions ...
  3. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  4. Gross Profit Margin

    A gross profit margin is a financial metric used to assess financial ...
  5. Gross Earnings

    1. For individuals, the total income earned in a year, as calculated ...
  6. Operating Income

    Operating income is the amount of money a company generates from ...
Hot Definitions
  1. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  4. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  5. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  6. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
Trading Center