What Is Profit?
Profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question. Any profits earned funnel back to business owners, who choose to either pocket the cash or reinvest it back into the business. Profit is calculated as total revenue less total expenses.
What Does Profit Tell You?
Profit is the money a business pulls in after accounting for all expenses. Whether it's a lemonade stand or a publicly-traded multinational company, the primary goal of any business is to earn money, therefore a business performance is based on profitability, in its various forms.
Some analysts are interested in top-line profitability, whereas others are interested in profitability before taxes and other expenses. Still others are only concerned with profitability after all expenses have been paid.
The three major types of profit are gross profit, operating profit, and net profit--all of which can be found on the income statement. Each profit type gives analysts more information about a company's performance, especially when it's compared to other competitors and time periods.
Gross, Operating, and Net Profit
The first level of profitability is gross profit, which is sales minus the cost of goods sold. Sales are the first line item on the income statement, and the cost of goods sold (COGS) is generally listed just below it. For example, if Company A has $100,000 in sales and a COGS of $60,000, it means the gross profit is $40,000, or $100,000 minus $60,000. Divide gross profit by sales for the gross profit margin, which is 40%, or $40,000 divided by $100,000.
Gross Profit=Total Sales−COGs
The second level of profitability is operating profit, which is calculated by deducting operating expenses from gross profit. Gross profit looks at profitability after direct expenses, and operating profit looks at profitability after operating expenses. These are things like selling, general, and administrative costs (SG&A). If Company A has $20,000 in operating expenses, the operating profit is $40,000 minus $20,000, equaling $20,000. Divide operating profit by sales for the operating profit margin, which is 20%.
Operating Profit=Gross Profit−Operating Expenses
The third level of profitably is net profit, which is the income left over after all expenses, including taxes and interest, have been paid. If interest is $5,000 and taxes are another $5,000, net profit is calculated by deducting both of these from operating profit. In the example of Company A, the answer is $20,000 minus $10,000, which equals $10,000. Divide net profit by sales for the net profit margin, which is 10%.
Net Profit=Operating Profit−Taxes & Interest