Profit describes the financial gain realized when revenue generated from a business activity exceeds the expenses, costs, and taxes needed to sustain the activity. Every business strives for profitability, directing the funds earned back to business owners for reinvestment, distribution to shareholders as dividends, or personal earnings.
Key Takeaways
- Profit is calculated as total revenue minus total expenses.
- Businesses report different types of profit: gross profit, operating profit, and net profit (also known as the “bottom line”).
- Profitable companies attract investors by offering dividends or reinvesting in growth, thereby increasing their stock value.
What Does Profit Tell You?
Profit is the money a business earns after accounting for all expenses. The primary goal of any business, whether a small lemonade stand or a large multinational corporation, is to generate profit. Analysts evaluate different forms of profitability to understand a company’s performance—gross, operating, and net profit, each found on the income statement. Gross profit calculates revenue minus the cost of goods sold (COGS), operating profit deducts operational expenses, and net profit factors in interest and taxes as well.
Gross, Operating, and Net Profit
Gross Profit
The first level of profitability, gross profit, is calculated as sales minus the COGS.
Gross Profit = Revenue - COGS
For instance, if Company A makes $100,000 in sales and the COGS is $60,000, then the gross profit is $40,000. To find the gross profit margin, divide the gross profit by sales, resulting in 40%.
Operating Profit
Operating profit, or earnings before interest and taxes (EBIT), further removes operating expenses, overhead costs, and depreciation & amortization.
Operating Profit = Revenue - COGS - Operating Expenses - Depreciation & Amortization
Net Profit
Net profit takes it further by including interest and taxes. Being the final figure on the income statement, it’s often called the “bottom line.”
Net Profit = EBIT - Interest Expenses - Taxes
The bottom line measures how profitable a business was in a specific period, deciding the funds available for dividends or reinvestment.
Where Does Profit Come From?
Economists have long debated the origins of profit. Karl Marx suggested profit arises from surplus labor extracted from workers. In contrast, modern thinkers propose that profit compensates for the entrepreneurial risk taken when starting a business. Others argue that profits stem from inefficient markets and imperfect competition.
What Is the Corporate Tax Rate on Profits?
In the U.S., the corporate tax rate on profits is currently 21%, having been reduced from 35% due to the 2017 Tax Cuts and Jobs Act.
What Does a Company’s Bottom Line Tell You?
The bottom line uncovers how profitable a company was during a specific period and its financial health future. A growing bottom line indicates strong financial performance and prospects, whereas a falling bottom line could signal underlying problems.
Related Terms: EBIT, gross profit margin, depreciation, amortization.
References
- Makadok, Richard. Invited editorial: The four theories of profit and their joint effects. *Journal of Management,*Vol. 37, No. 5. 2011, Pp. 1316-1334.
- Tax Policy Center. “How does the corporate income tax work?”
