What do local mom-and-pop businesses and global corporation have in common? They are trying to generate a profit.
A profit is a financial gain received through the difference of the amount earned and the expense costs.
While the textbook definition of a profit is pretty simple to understand, there’s more to this term than just “making more money than you spend.”
What it is
You can think of profits as the revenue remaining after accounting for all business expenses. The calculation is pretty simple: You simply take the total revenue the company rakes in and subtract it by the company’s total expenses.
A company’s revenue is the amount of money received in exchange for selling a product or service. On the other hand, expenses can include a variety of things, from salaries and advertsing, to production costs and taxes.
Profits are the endgame for every single CEO out there. Everyone wants to get rich or die tryin’, and, for many people, profit is how we ultimately determine the success (or failure) of the company.
More than one type of profit
Profit isn’t a one size fits all term. From a business standpoint, there are actually three types of profits: gross, operating and net. Each of these is an increasingly in-depth and nitpicky way to examine the relation between the company’s revenue and expenses.
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Gross profit takes a general look at things, only looking at direct expenses – in other words the return from the sale of a good versus the cost of producing it. To put it into perspective, if a local boutique makes $10,000 off of sales but it cost $2,000 to make the clothes, then the gross profit of the boutique would be $8,000.
Taking it a step further, we need to factor operating profits, which accounts for the costs that go towards paying employees’ wages and any other administrative costs. We can find this figure by taking our freshly calculated gross profit and subtracting the operating expenses. Following the previous example, if our gross profit for the boutique was $8,000 but it costs $1,000 to pay all employees, then our final operating profits would be $7,000.
The final level of profit calculation takes into consideration all taxes and interest that must be paid. This is called net profitability. Let’s say taxes and interest payments were a thousand dollars a pop. After deducting the $2,000 worth of expenses, the boutique would be left with a $5,000 net profit.
Profits … now what?
Once the profits are made, that’s only the beginning for the company. The owners can do any number of things; raise employee wages, pay back shareholders, reinvest the money, buy new machinery to produce more goods or buy more expensive resources to produce a higher quality of good…you name it, the owner has the power to spend money for it.
Profits are an important indicator of the viability of a company. Obviously, the goal is to make a profit, and if the company can’t even do that, things aren’t looking too good. Profits (or losses) can be used to analyze business performance and help the company improve in the future.
By scrutinizing gross, operational and net profits, the boss can adjust the business model to cut expenses and maximize the company’s wealth.
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