Profit is one of the most important terms in business and finance. Properly understanding what profit is allows you to have a better idea of how a company is performing.
It is essentially the financial reward that business people aim to receive in compensation for the risks that they take.
Net profit is what is left after all the costs of running a company – in most cases including taxes paid – have been added up and taken from its sales revenue.
Profit is not just the difference between the price of product or service and its cost.
When calculating profit you must also account for overhead costs, which include: fixed costs – periodic costs that remain the same, i.e. salaries, rent, and insurance – and variable costs – costs that fluctuate with output, such as labor and materials.
A graph that illustrates the point of maximum profit relative to revenue and costs:
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 (fixed costs, variable costs, and taxes).
Virtually everybody is interested in 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 to know which is which.
Below are some examples of different profit measures:
- Gross profit: sales revenue minus cost of goods sold (COGS). Gross profit is also known as gross income. Essentially, it is the income from gains from whatever source before being charged taxes.
- 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, plus its ability to repay its debt. EBITDA give lenders a better idea of what kind of risk the borrower is (rather than simply looking at its profits).
- Earnings Before Interest and Taxes (EBIT) : sales revenue (income generated) minus cost of goods sold and all expenses except for interest and taxes.
- Earnings Before Taxes (EBT) 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
The definition of profit, according to Miriam Webster, is:
- a valuable return
- the excess of the selling price of goods over their cost
- net income over a given period
- 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 in the internet, you will come to the conclusion that the two terms are used interchangeably. The British and Irish tend to use the plural (countable) term more frequently.
Some purists insist that profit is an accounting term that refers to the difference between the price and cost of a product/service, while profits is an economic term that describes the gains derived from an investment when total returns are greater than invested capital. They add that profits are usually measured over a period of time.
Essentially, however, as far as today’s usages of ‘profit’ and ‘profits’ are concerned, they both have the same meaning.
Famous quotes with the word ‘profit’
American engineer, statistician, professor, author, lecturer, and management consultant, William Edwards Deming (1900-1993) once said about profit:
“Profit in business comes from repeat customers, customers that boast about your project or service, and that bring friends with them.”
Profit or to profit in non-business contexts can mean to gain advantage or benefit by doing something.
This quote by Plutarch (circa. AD 46 – AD 120), a Greek historian, biographer and essayist, is an example of ‘profit’ with a non-business/financial meaning:
“Know how to listen, and you will profit even from those who talk badly.”
Video – What is profit?