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, distribute it to shareholders as dividends, or reinvest it back into the business.
- Profit is calculated as total revenue less total expenses.
- For accounting purposes, companies report gross profit, operating profit, and net profit (the "bottom line").
- Profitable companies are attractive to investors as profits are either returned to shareholders as dividends or reinvested in the company, increasing stock value.
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.
The word “profit” comes from the Latin noun profectus, meaning “progress,” and the verb proficere, meaning “to advance.”
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:
Gross Profit = Revenues - COGS
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.
Operating profit removes operating expenses like overhead and other indirect costs as well as accounting costs like depreciation and amortization. It is sometimes referred to as earnings before interest and taxes, or EBIT.
Operating Profit = Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Depreciation & Amortization
Net profit furthermore removes the costs of interest and taxes paid by the business. Because it falls at the bottom of the income statement, it is sometimes referred to as the firm's "bottom line."
Net Profit = EBIT - Interest Expense - Taxes
The bottom line tells a company how profitable it was during a period and how much it has available for dividends and retained earnings. What's retained can be used to pay off debts, fund projects, or reinvest in the company.
Where Does Profit Come From?
In a capitalist system where firms compete with one another to sell their goods, the question of where profits come from has been one of interest among economists. Karl Marx, for instance, argued that profits arise from surplus labor extracted from workers by business owners. Modern thinkers suggest that profits compensate for the risk that entrepreneurs take on when starting a business. Others argue that profits arise from inefficient markets and imperfect competition.
What Is the Corporate Tax Rate on Profits?
In the U.S., the corporate tax rate on profits is currently 21% (reduced from 35% since the 2017 Tax Cuts and Jobs Act).
What Does a Company's Bottom Line Tell You?
The bottom line tells a company how profitable it was during a period and how much it has available for dividends and retained earnings. What's retained can be used to pay off debts, fund projects, or reinvest in the company. An increasing bottom line is a sign that a company is growing, while a shrinking bottom line could be a red flag.