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. What does operating profit margin tell a business owner?

    Learn about the operating profit margin, how it is calculated and what it says to both business owners and investors about ... Read Answer >>
  2. What is the formula for calculating profit margins?

    Learn about gross, operating and net profit margins, how each is calculated and how they are used by businesses and investors ... Read Answer >>
  3. Does gross profit include tax?

    Find out what gross profits are, how they are calculated, how they are interpreted by investors and whether taxes are taken ... Read Answer >>
  4. How do operating expenses affect profit?

    Explore how operating expenses and the cost of goods sold can either increase or decrease a company's profits on an income ... Read Answer >>
  5. What are the differences between gross profit and net income?

    Find out how companies determine gross profits and net income, and how these figures provide quick snapshots of their financial ... Read Answer >>
  6. What is the difference between operating income and revenue?

    Understand the definitions of revenue and operating income, how they are calculated and interpreted, and how operating income ... Read Answer >>
Related Articles
  1. Investing

    Gross, Operating and Net Profit Margins

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

    Is Net Income The Same As Profit?

    Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
  3. 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.
  4. 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.
  5. Investing

    Gross Profit

    Gross Profit is one of several important measurements of a company's profitability.
  6. Investing

    Operating Profit

    Operating profit is the profit generated from the core business of a company before accounting for interest and taxes.
  7. Taxes

    What is Profit Before Tax?

    Profit before tax measures a company’s profits before it pays corporate income tax.
  8. Investing

    How To Value A Real Estate Investment Property

    Two common methods for real estate valuation are the discounted net operating income and gross income multiplier approaches.
  9. Investing

    Contrasting Gross Profit And Net Income

    The terms “profit” and “income” are largely interchangeable. But there is a real difference between the words “net” and “gross” in the business world.
  10. Investing

    Net Operating Income

    Net operating income (NOI) reflects income after operating expenses are deducted, but before income taxes and interest are deducted.
RELATED TERMS
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the ...
  2. Profit

    A financial benefit that is realized when the amount of revenue ...
  3. Net Income - NI

    A company's total earnings (or profit). Net income is calculated ...
  4. Gross Margin

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

    A financial metric used to assess a firm's financial health by ...
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
Hot Definitions
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  2. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  3. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  4. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  5. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  6. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
Trading Center