What is profit? Measures of profit
Profit is one of the most important terms in business and finance. Properly understanding what profits are allows you to have a better idea of how a company is performing.
It is essentially the financial reward that business people strive to receive. A reward in compensation for the risks that they take.
Net profits are what is left after we add up all the costs of running a company and subtract the total from its sales revenue. In most cases, we calculate net profits after the company has paid its taxes.
Profit is not just the difference between the price of product or service and its cost.
When calculating a business’ profits, you must also account for overhead costs. Overhead costs include fixed costs, i.e., periodic costs that remain the same, such as salaries, rent, and insurance. They also include variable costs i.e., costs that fluctuate with output, such as labor and materials.
In addition to overhead costs, you also have to calculate how much tax you must pay out of your income.
Profit is equal to the sale of a product minus all these operating and other expenses, i.e., fixed costs, variable costs, and taxes.
If a company is making a profit it is profitable. If it is active and also profitable, it is a going concern. Profitable is the opposite of unprofitable. When a company is losing money or just breaking even, we say that it is unprofitbable.
We call organizations that try to have greater revenue than costs ‘for-profit organizations.’ They form a crucial part of a capitalist, free-market economy.
Virtually everybody in the world of business focuses on profits, especially analysts, investors, the media, etc. However, when a company’s board of directors say “We are profitable,” what exactly do they mean?
It is important to realize there are several different ways a firm can make a ‘profit.’ It is crucial for investors, above all, to know which is which.
Below are some examples of different profit measures:
- Gross profit: sales revenue minus the cost of goods sold (COGS). We also refer to gross profit as gross income. Essentially, it is the income from gains from whatever source before tax.
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): sales revenue minus cost of goods sold and all expenses apart from interest, depreciation, amortization, and taxes. This measure provides an accurate picture of a firm’s cash flow. It also tells us how easily it can repay its debt. EBITDA gives lenders a better idea of what kind of risk the borrower is (rather than simply looking at its profits).
- EBIT (Earnings Before Interest and Taxes)) : sales revenue minus cost of goods sold and all expenses except for interest and taxes.
- EBT (Earnings Before Taxes) or Net Profit Before Tax: sales revenue minus cost of goods sold and all expenses apart from taxes.
- Earnings After Tax : sales revenue minus all expenses.
The definition of profit
Miriam Webster has the following definition:
- 1. a valuable return
- 2. the excess of the selling price of goods over their cost
- 3. net income over a given period
- 2. ratio of profit in a year to the amount of capital invested
Profit vs. Profits
Which one is correct, ‘profit’ or ‘profits’? If you search through a few hundred documents on the internet, you will conclude that authors use them interchangeably. The British and Irish tend to use the plural (countable) term more frequently.
Some purists insist that the singular form is an accounting term that refers to the difference between the price and cost of a product/service. The plural form, however, is an economic term that describes the gains we derive from an investment when **total returns are greater than invested capital. They add that we usually measure profits over specific periods.
** Total return equals all the dividend or interest payments plus the capital gain (the asset’s rise in value).
Essentially, however, they both have the same meaning.
Some companies, when they have a good year, give their employees an additional payment. We call this extra money a ‘bonus.’ Bonuses are either related to a company’s profit or an individual employee’s performance.