What Is Profit?
Profit is a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs, and taxes needed to sustain the activity. Any profit that is gained goes to the business's owners, who may or may not decide to spend it on the business. Profit is calculated as total revenue less total expenses.
What Does Profit Tell You?
Profit is the money a business makes after accounting for all expenses. Regardless of whether the business is a couple of kids running a lemonade stand or a publicly traded multinational company, consistently earning profit is every company's goal. As a result, much of 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 expenses, such as taxes and interest, and still others are only concerned with profitability after all expenses have been paid.
There are three major types of profit that analysts analyze: gross profit, operating profit, and net profit. Each type gives the analyst more information about a company's performance, especially when compared against other time periods and industry competitors. All three levels of profitability can be found on the income statement.
Gross, Operating, and Net Profit
The first level of profitability is gross profit. Gross profit 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.
The second level of profitability is operating profit. Operating profit 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%.
The third level of profitably is net profit. Net profit 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%.