Profit is the difference between revenue and expenses, and serves as a key indicator of business health. It’s important to understand the nuances of each type of profit, and track them on a regular basis, in order to make smart decisions that drive growth and long-term success.
Profit can be measured using three different metrics, each found on the income statement: gross profit, operating profit, and net profit. Each provides analysts with more information about a company’s performance, and can be analyzed against competitors or over time.
For example, if a company’s sales are $100,000 but their cost of goods sold (COGS) is $60,000, the gross profit is $40,000. This metric gives insights into how well a company manages its costs. Likewise, operating profit — or earnings before interest and taxes — is calculated as sales revenue minus COGS, depreciation, and amortization. This metric helps analysts compare companies by adjusting for differences in capital structure and tax rates.
Net Profit is the final calculation of all revenue minus all expenses, and is also known as the “bottom line.” This metric gives analysts a full picture of a company’s profitability, and can be compared to total assets to determine financial health. It is important to note that many new businesses are not profitable at first, and it can take years for a startup to reach breakeven. Profitability can be improved through a variety of strategies, including reducing costs by leveraging the Pareto Principle and focusing on the most lucrative customers.