The earnings generated when the income from a business activity exceeds the expenses.

Author: Savan Sabu
Savan Sabu
Savan Sabu
Savan Sabu was brought up in Dubai, did Bachelor of Commerce Professional from a prestigious college (Christ College) in India. Later on, he worked as a Finance Research Analyst intern and was promoted to Editor In Chief with WSO where he developed working skills in multi-cultural environments, multi-tasking, improved research, and coordinated teamwork. Also, I could learn different concepts in finance and participate in bootcamps. Currently, pursuing a post-graduate degree in Supply Chain & Logistics.
Reviewed By: Ka Chun Chiu
Ka Chun Chiu
Ka Chun Chiu
Last Updated:May 31, 2024

What Is Profit?

A profit is earned when the income generated from a business activity exceeds the expenses, labor costs, interest on debt, fees, and taxes involved in maintaining the business. To put it in other words, the value that is left over after a company's expenses have been paid.

Any earnings generated are returned to the business owners, who can choose to keep the money or reinvest it. It is the reward that business owners receive for their investment.

The total revenue is subtracted from the profit calculation by the whole expense. The net profit can be found on the income statement

If the value that remains after expenses have been deducted is positive, the company is considered to make a surplus. If the value is negative, it is said to be a loss, and the company may go bankrupt if it continues to lose money for an extended period.

Profit is paid directly as income for small businesses, while for corporations, it is frequently provided to shareholders as a dividend. Yields and income are two terms that signify the same thing.

Every business, whether a street vendor, a public company, or a multinational corporation, is basically motivated by profit; hence, business performance is measured in terms of revenue.

Some analysts are more concerned with gross sales, others are more concerned with revenue before taxes and other expenses, and others are solely concerned with earnings after all costs have been paid.

Earnings and profits are two different terms for the same thing. In quarterly reports, public firms listed on the stock exchange announce them every four months during the earnings season (March, June, September, and December). Stock analysts also make predictions about future earnings.

The stock market's performance is heavily influenced by the earnings season. If a company's earnings are higher than expected, the stock price usually rises. Conversely, costs will normally fall if earnings are lower than projected.

Monitoring earnings seasons is crucial during the economic cycle's transition phases. If earnings improve faster than predicted after a downturn, the economy may be on the mend.

The business cycle is about to enter its expansion phase. Earnings reports below expectations could signify the start of a recession.

Key Takeaways

  • Profit is the financial gain realized when the revenue generated from business activities exceeds the expenses, costs, and taxes involved in sustaining the activity.
  • Profit is essential for the survival and growth of a business. It enables reinvestment in the business, repayment of debts, and distribution of dividends to shareholders.
  • A consistent profit is a sign of a successful business, reflecting effective management and a strong market position.
  • A business can be profitable but still face cash flow problems if it does not manage its cash effectively.

Types of Profits

In this article, we shall delve into the three basic types found on the income statement. Each type provides more information to analysts about a company's performance, especially when compared to other competitors and other periods.

Gross Profit

After deducting the total cost of sales, or total cost of goods sold (COGS), it is the amount that remains left over from the total sales income. The only costs that seem to be variable are those that are required to make each product, such as workers employed, materials, and fuel.

Fixed costs, on the other hand, such as plants, equipment, and the human resources department, are not included. To determine which product lines are the most valuable, they are compared. In most businesses, it is the first subtotal seen on the income statement.

Example To Calculate Gross Profit
Particulars Amount
Total Revenue $850,000
Total cost of goods sold $650,000
Gross Profit $200,000

Operating Profit

It includes variable and fixed costs; hence it is known as Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) because it doesn't have some financial charges. It's the most prevalent, particularly for service businesses that don't sell anything.

After calculating all operating expenses deducted from revenue, the value that remains is called (EBITDA). This is usually seen in the income statements as the second sub-total.

Sales expenses, marketing, advertising, salaries and wages, employee benefits, depreciation, rent, commissions, and other costs related to the business's continuing operations are operating expenses.

Example Of Calculating Operating Profit
Particulars Amount
Cost of sales $88,265
Marketing $7,233
Technology and content $16,085
Salary and employee benefits $45,786
General and administrative $2,432
Other operating expenses $167
Operating Profit $159,968

Net Profit

It is also used to refer to net income or net earnings. After calculating all expenses, including interest and taxes, that have been deducted from revenue, the value remains.

It is the most comprehensive estimation of the company's income; unfortunately, it can also be misleading.

Net earnings, also called net income, are usually found on the final line of an income statement. Non-operating expenses like interest and taxes are included in net earnings.

It is the most comprehensive estimation of the company's income; unfortunately, it can also be misleading.

Net earnings, also called net income, are usually found on the final line of an income statement. Non-operating expenses like interest and taxes are included in net earnings.

Example To Calculate Net Profit
Particulars Amount
Gross Profit $12,000
Operating Profit ($3,000)
Sales ($4,000)
Net Profit $5,000

The profit margin (which reveals how effectively a corporation manages its cash flow) is used by businesses to evaluate all three types. That is the yield divided by the revenue, whether gross, operating, or net.

Each industry has its own set of ratios. A high profit-to-revenue ratio indicates that it earns a lot of yield for each dollar of revenue. A low cost-to-profit ratio suggests that the company's costs are eating into its earnings.

Profit margins allow investors to compare the performance of large and small businesses. Because of its size, a large corporation will make a lot of money, and a small business may have a bigger margin and, as a result of its efficiency, be a good investment.

Investors can compare a company's performance over time by using margins. Yield will rise as the company expands; however, its margin may decrease if it does not improve its efficiency.

Example of Gross Profit Margin
Particulars Amount
Total product revenue $50
Total production cost $15
Gross Profit $35
Gross Profit Margin $70


An Example For Calculating Gross, Operating, And Net Profit

An income statement of Amazon for the year 2020, where you can see the gross, operating, and net profit in the article.

Income Statement Of Amazon for the year 2020
Particulars Amount
Net Purchase $94,665
Net sales $277,866
Gross Profit $183,201
Operating expense:  
Cost of sales $88,265
Marketing $7,233
Technology and content $16,085
General and administrative $2,432
Other operating expenses $167
Total Operating Expense $114,182
Operating Profit $69,019
Interest Income $100
Interest expense ($484)
Other income/expenses $90
Total Non-operating Income/Expense ($249)
Income before tax $3,829
Provision for tax ($1,425)
Net Profit $2,467

Ways To Increase Profit

In this article, we shall dive into the main two ways.

By Increasing Income

The ways to boost income are by raising prices, growing the number of customers, or expanding the number of things supplied to each customer.

Whether there is enough demand, raising the price will increase income. Customers must have a strong desire for the product to pay greater pricing. It might be difficult to increase the number of customers.

It necessitates increased marketing and sales efforts. However, the increased quantity of products sold to each consumer is less expensive. The main thing is to know your customers well enough to know what other things they could want.

By Cutting Costs

To a degree, cutting costs is a reasonable move. It improves a company's efficiency and, as a result, its ability to compete. Moreover, once charges are reduced, the company can lower pricing to entice customers away from competitors.

It can also put this efficiency to good use by improving service and responding more swiftly. Companies that seek to boost earnings swiftly can lay off staff which is quite risky. The company's essential skills and knowledge will be lost over time.

It is possible that if more businesses do this, the economy will suffer since there wouldn't be enough people making excellent money to keep demand going. The same thing happens to firms when outsourcing jobs to low-cost countries.

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