When a business gains income from a business activity, the amount of revenue that exceeds all the expenses of that activity is called profit. Or in other words: Profit is the excess income over a company’s expenses.
Types of profit
Three major types of profit can be differentiated when analyzing the profitability of a business.
- Gross Profit = Sales – Cost of Goods Sold (Doesn’t include expenses like taxes, administration or interest payments.)
- Operating Profit = Gross Profit – Operating Expenses (Operating Expenses include pretty much all costs necessary to run the business e.g. cost for insurance, administration, maintenance, warehousing, transportation, marketing, wages…)
- Net Profit = Operating Profit – (Taxes + Interest Payments) (Net Profit is the income left over after all costs have been deducted.)
A company sells chairs and has an income of $100,000. The materials for producing the chairs cost $30,000. The company has $50,000 operating expenses, $5,000 expenses for taxes and $5,000 for interest payments. The resulting profits are:
Gross Profit: $70,000 = $100,000 – $30,000
Operating Profit: $20,000 = $70,000 – $50,000
Net Profit: $10,000 = $20,000 – ($5,000 + $5,000)
There are many factors to consider if you want to invest into a business. Profitability is probably one of them.
So… what do you think is the most important type of profit to look at, when analyzing a business? Which other indicators should be considered urgently?
Feel free to ask questions, comment on my thoughts and give your honest feedback. If you are interested in learning and discussing more financial terms together, let me know. Finally.. thank you for taking your time, reading this and sharing your thoughts with us!