What Is Profit? Gross Profit vs Net Profit

Profit is a familiar term in business that you need to know to measure how well a business is performing. So What is profit? How do you calculate profit? Gross profit vs net profit how do they differ? In this article, Mona Media will walk you through profit in detail.

What is profit?

Definition

Profit is the difference between total revenue and total cost over a set period. Put simply, it is the gain a business keeps after deducting all kinds of costs. It is also the main goal of individuals and businesses when they do business: to earn a return.

The formula

There are 2 basic ways to determine profit:

Method 1: Total profit is the difference between total revenue and total cost.

Profit = Total revenue – Total cost = TR(Q) – TC(Q)

Method 2: Total profit is the profit per unit of product multiplied by the number of units sold.

Profit = Profit per unit x Number of units sold

Where:

• Profit per unit = Selling price – Average total cost = P – ATC
• Average total cost (ATC) = Total cost (TC)/Q

What profit means

Profit is the most important economic goal and the condition for a business to survive and ways to grow the business. It is also a positive sign that an organisation or business is doing well.

Profit is capital the company can use for many purposes, such as:

• Maintaining the workplace, or buying, replacing and upgrading equipment.
• Investing in high-cost items.
• Investing in new products, services and staff.

With good profit, businesses can expect to keep growing and prospering in the future.

Factors that affect profit

There are 3 main factors that affect profit: production scale, inputs and selling price.

Production scale

Changes in supply and demand change product prices. This is inevitable, and it directly affects production scale and the profit of a business.

Inputs

The price and quality of inputs, and how inputs are combined in production, also affect profit.

These include labor, raw materials, production equipment and so on. They directly affect business costs and therefore profit.

Selling price

The selling price of goods and services, together with all actions to speed up sales and recover capital, especially marketing activities and the company's finance work, are the next factors that change profit.

Types of profit investors should care about

There are 3 main types of profit: gross profit, operating profit and net profit. All of them can be found on a company's income statement.

Each type of profit gives analysts more specific information about how well the business performs. These figures also let analysts compare a company with its competitors, or compare its performance across specific periods.

Gross profit

Gross profit is profit after subtracting the direct cost of producing goods (cost of goods sold) from total revenue (sales). The cost of producing goods is unavoidable, and every investor treats gross profit as a measure of a company's overall ability to make a profit.

Formula:

Gross profit = Total sales – Cost of goods sold (COGS)

Gross profit margin = Gross profit / Sales.

In the income statement, sales is the first line to appear, followed directly below by cost of goods sold.

Example: Company X has revenue of 100 million VND and cost of goods sold of about 60 million VND. Its gross profit is 40 million VND (100 – 60 = 40 million), and its gross profit margin is 40% (40/100 million).

Operating profit

Operating profit is profit from business operations, after cost of goods sold and operating costs (overhead, administration and selling costs).

Operating profit is calculated by subtracting operating expenses from gross profit. Formula:

Operating profit = Gross profit – Operating expenses

Operating profit margin = Operating profit / Total sales

If gross profit tells you how profitable the business is after direct costs, operating profit tells you how profitable it is after operating costs.

Example:

If Company X has operating expenses of 20 million VND, its operating profit is 20 million VND (since gross profit is 40 million). The operating profit margin is 20% (20 million operating profit / 100 million sales = 20%).

Net profit

Net profit, also called the bottom line, is what remains after subtracting all costs (including tax and interest) from total revenue. Investors often use all three profit figures to judge a company's health, but net profit is more widely accepted and is treated as the general definition of profit.

Formula:

Net profit = Operating profit – Taxes and interest

Example: 

If Company X pays 5 million VND in interest and 5 million in tax, net profit is operating profit minus these two items: 20 million – 10 million = 10 million. Net profit is 10 million VND and the net profit margin is 10% (10 million/100 million).

Gross profit vs net profit

From the types of profit above, you can see the difference between gross profit and net profit.

• Gross profit is the income left after paying all the direct costs of producing the product.
• Net profit is what remains after subtracting all other costs (fixed costs such as advertising, asset depreciation, equipment rental, insurance, property tax, staff salaries and so on).

What is the difference between revenue and profit?

Revenue is the total income generated from selling goods or services. Profit, or net profit, is the income left after subtracting costs, additional income streams, debt and operating expenses.

In a company's income statement, revenue is the figure shown at the top (top line). It is the income the company generates before deducting costs.

Profit (the bottom line) is net income on the income statement. Profit measures vary across statements, and the three types described above are the most common.

The example below will help you understand revenue and the types of profit in an income statement:

When people talk about a company's profit, they usually mean net profit rather than operating or gross profit. Net profit is what remains after all kinds of costs are deducted.

From the example, J.C.Penney generated 12.50 billion USD in revenue but still lost 116 million USD. The cause is debt or costs that exceeded income.

Effective ways to increase profit

Businesses keep looking for ways to improve net profit. So how do they raise profit? Here are some ways well-known businesses use.

• Increase revenue is what many businesses choose to raise net profit, in 3 ways: raise the price of products or services, sell more products, or find new customers to grow sales.
• Cutting costs is also a common way to raise profit. Companies can cut direct costs tied to products and services, or indirect costs such as overhead, whether or not they relate directly to the product or service.
• Dropping products that do not sell well and poor-quality products lowers production costs and improves profit effectively.
• Reducing inventory can help a business cut costs and improve net profit, especially if it rents outside storage.

One fairly comprehensive method that many businesses now invest in is using modern software, such as MONA Ecommerce multichannel sales management software. Its useful features optimise processes and reduce staffing needs while keeping management and operations effective and revenue growing. Adopting professional sales software is seen as a smart investment, an essential “step” toward profit growth in today's competitive market.

Those are some tips on What is profit? Gross profit vs net profit, how to calculate profit, and how profit differs from revenue. We hope this article from Mona Media helps you understand profit better and shows you how to calculate and grow your business's profit effectively.

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