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Finance glossary

How to calculate profit

Bristol James
2 Min

Profit is a common measure of success for a business, used by company executives and business owners to calculate the bottom line. Essentially, profit signal to analysts and investors that a company is earning more than it spends. There are three measures for profit: operating profit, gross profit, and net profit.

How operating profit, gross profit and net profit work together:

Gross profit: subtracting the business’s cost of goods and services (COGS) from revenue to make sure you’re operating a profitable business model.

Equation: Revenue – COGS = Gross Profit

Example: if a chocolate bar cost your business $.70 and you’re able to sell it for $1.25, your gross profit on each chocolate bar is $0.55

$1.25 – $0.70 = $0.55

 

Operating profit: shows the business is making money after paying COGS, and any interest and expenses.

Equation: Gross profit – Operating Expenses = Operating Profit

Example: let’s say a company has a total revenue of $300,000, COGS of $120,000 and operating expenses of $35,000. Operating revenue will be $145,000.

$300,000-$120,000-$35,000= $145,000

 

Net profit: accounts for total profits after all expenses, COGS and taxes are paid.

Equation: Operating profit – taxes = net profit

Example: Let’s say a company sold $100,000 worth of goods, which cost them $45,000 to create and they spent an additional $5,000 on operating expenses (eg. Office space, computers, etc) and then $17,000 on tax. Total net profit would be $33,000.

$100,000-$45,000-$5,000-$17,000 = $33,000

How is profit used in small businesses vs publicly owned and traded businesses?

In a small business, profits usually go directly to the owner, whereas in publicly owned and traded businesses, a per centage of the profits will be used to pay out stockholders in dividends.

The remaining profits will likely go to the owner(s), be reinvested back into the business, or a combination of the two.

Why is profit important?

It helps businesses grow and expand: profit can be used to reinvest into the business, whether it be through product improvements, new hires, upgrading equipment, and more. Being a profitable business allows the opportunities for improvement and growth.

It keeps investors engaged: the better the profits, the better the dividends paid to investors. By showing a strong bottom line, investors can rest easy knowing they made the right choice with a business.

Improves stock value: for public companies, quarterly earnings will directly impact the stock market prices. Although, in these reports, profit isn’t the only thing that can influence stock value, as companies can report on other measures and future forecasts.

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