What Are Profits?
Profits can be defined as the part of the revenue generated by the company that is left after all the expenses and debts have been paid. The revenue that is generated from the sales of the products or services of a company is first used to clear all the expenses. The money that is left is considered to be the profit of the company.
Gross Profit and Operating Profit
There are various types of expenses that a company needs to pay off before calculating its profits. Gross profits can be defined as the profits calculated when the company has paid off its direct expenses. Direct expenses are those expenses that are incurred in the cost associated with the sale of the company’s products and services. Gross profit can simply be calculated by subtracting the cost of goods and services sold from the total revenue generated by the company.
Operating profit on the other hand can be defined as the net earnings of a company without subtracting the taxes and interests that are left to be paid. These earnings are generated from the core and primary functions of the company’s business. Operating profit can be calculated by deducting the depreciation and amortization and the operating expenses from the gross profit of the company.
What is Net Income?
The net income or net earnings of a company is the actual revenue that is generated by the company. It can only be calculated when every single expense including the cost of goods, operating expenses, taxes, interests, depreciation, and fixed and variable costs has been deducted from the total revenue generated by the company. The net income of a company is a piece of important information for the investors who want to invest their money into the business. The net income also indicates the profitability of the company by showing how much earnings exceed the expenses incurred by the company.
Differentiation table for Gross Profit, Operating Profit, and Net Income
|Point of Difference||Gross Profit||Operating Profit||Net Income|
|Definition||Gross Profit is the revenue that the company generated after deducting all of its direct expenses.||The Operating profit is defined as the revenue that is left after the company has paid all of its operating expenses.||The net income of a company is the total revenue left after deducting every single expense and debt.|
|Purpose||Gross profit is used to calculate a rough estimate of how profitable is the business.||Operating profit indicates the allocation of resources to different expenses being incurred in the business activities.||The net income is the number that helps in assessing the actual profitability of the company.|
|Advantages||It helps in eliminating any extra cost of goods and services being manufactured and sold by the company.||It helps in controlling any unnecessary operating expenses which may be affecting the overall profitability.||The net income is used to assess the financial performance of the company over a particular period.|
|Examples||Variable costs such as raw materials, labor costs, wages, salaries, etc.||Operating expenses include rent, fixed costs, depreciation, and amortization.||Every single variable and fixed costs, operating expenses, and any other expenses.|
Profit is the money that is left after every expense of the company has been paid. Gross profit is the rough estimate of a company’s profitability and financial performance. Operating profits can be calculated by deducting all the operating expenses from the gross profits such as depreciation and fixed costs. Finally, the net income of a company is the actual representation of its profits and financial performance. All the three types of profits are necessary for different types of assessments in the company and in calculating the overall expense to revenue ratio.
The gross profit of a business can be calculated by deducting the direct expenses from the total revenue that the company has generated from the sale of its products and services. The direct expenses include the cost of selling those products and services.
When a company generates revenue, it needs to eliminate every single expense from it in order to know the actual profitability of the company. When you deduct every single expense from the total revenue of the company, the money that is left is the net income or the profit that the company has earned.
In order to calculate the expenses of a business, it is necessary to calculate the gross profit and operating profit first. It indicates deducting every single expense starting from the variable cost to fixed cost and including depreciation and taxes as well. Calculating these two figures can give you an exact idea of the expenses of running the business and an idea of how to control it.
Reshma Ali has great expertise in mergers & acquisitions, Financial planning, and international company formation and offers advice and knowledge to help businesses achieve their objectives.