Profit Meaning
Profit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. The concept is fundamental to all business activities.
Businesses are evaluated based on this metric. It is further classified into three types—gross Profit, Operating Profit, and net profit. In order to divide earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more among a group of owners, concepts like profit ratio and profit-sharing are used.
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Key Takeaways
- Profit refers to the total earnings left after settling all direct and indirect expenses.
- In everyday scenarios, the term does not always equate to financial gain or money earned; there are different kinds of profit.
- It is often considered the root cause of capitalism and free-market economies. Without monetary gains, no business can continue operations.
Profit Explained
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Profit is the amount of revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more left with a business after deducting all expenses. In economics, a profitable company is the one that generates considerable revenue and still takes home a reasonable amount—after settling all the liabilities. In common parlance, though, the term does not always refer to monetary gains.
The primary goal of any business is to earn profits; without it, no company can continue business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more. When a firm makes gains monetarily, it is perceived as successful. And as a consequence, it becomes deep-rooted. Therefore, profit is called the root cause of capitalismCapitalismCapitalism is an economic system consisting of businesses, resources, capital goods, and labour. Private entities own it, and the income is derived by the level of production of these factors. Because of the private hands, these entities can be operated efficiently and maximize their production activity also.read more. Capitalism is designed around monetary gains—it is a race to earn more. To achieve that, businesses come up with new ideas, marketing campaigns, and sales strategies.
When multiple partners are involved, earnings are divided among them—profit sharing planProfit Sharing PlanA profit-sharing plan is a defined contribution pension plan in which workers and employees are given the opportunity to get their share in the company's overall profit, incentivizing them to contribute more and more to the company's profit and motivating them to give their best efforts.read more. Business owners enter agreements to split the net incomeNet IncomeNet income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.read more in a specific way. For example, one owner could receive a large percentage, and the other could receive a smaller share. In order to improve profit ratios, businesses try to cut costs and increase revenue.
Profit Types
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#1 – Gross Profit
Also known as gross incomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity.read more, it is computed by subtracting the manufacturing cost of a product from total sales. Manufacturing cost is also called the cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more (COGS).
Gross income is mentioned in the company’s income statement. Gross income constitutes variable costVariable CostThe variable costing formula evaluates the direct cost and other variable manufacturing expenses incurred on each product unit. It is computed as the sum of direct labor cost, direct raw material cost, and variable manufacturing overhead divided by the total number of units produced.read more. Fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more like the plant, machinery, salaries, and equipment are not included. The gross income determines business efficiency.
#2 – Operating Profit
It is generally referred to as EBITEBITEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more (Earnings Before Interest and Tax). It includes both variable costs and fixed costs. Manufacturing, staff, and administration constitute primary expenses for any business.
#3 – Net Profit
It is an apt representation of how much a company takes home. It includes every cost the company incurs from start to finish and then subtracts this amount from total revenue.
In order to increase return on investment (ROIROIThe return on investment formula measures the gain or loss made on an investment relative to the amount invested. The net income divided by the original capital cost of investment. Return on Investment Formula = (Net Profit / Cost of Investment) * 100 read more), businesses invest funds in the stock market and other financial instruments. Many companies generate excess amounts of hard cash and choose not to disclose it. Therefore, this valuation metric can be misleading.
Calculation
It is calculated by using the following formula:
Profit = Total revenue – Total expense.
Let us assume that a company manufactures bags, the total revenue for the company in the year 2021 was $1500,000, and the total expense that the company incurs for the operations is $850,000 (inclusive of fixed cost, variable cost, and miscellaneous costs for the whole year).
On applying the formula, we get:
1500,000 – 850,000 = 650,000
Thus, the bag manufacturing company will make a profit of $650,000 in 2021.
Examples
Let us look at some examples to understand the practical application of this concept:
Example #1
Richard opens a small eatery in the local market. He hires two workers—one employee cooks, the other cleans. Richard sits at the counter and manages the bills himself. He spent on rent and operating capital. The operating capital comprises raw materialRaw MaterialRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more, cooking expenses, decoration, light, furniture, and music.
Within a month, the business made a total revenue of $4000. Within the same period, Richard clears liabilities. He covers wages for two workers, spends on operating expenses, and miscellaneous expenses. After subtracting all those expenses from the total revenue, he is left with $1200. This amount is referred to as profit.
Example #2
In April 2022, Samsung reported a 50% hike in their quarterly profits (compared to their last big earnings since 2018). The chip business accounts for half the profits.
Samsung publicly admitted that the figures were more than what they expected. Their revenue rose 18% from their 2018 hike. Yet, with the rise in inflation, the demand for smartphones, laptops, and PCs might plummet.
Frequently Asked Questions (FAQs)
It is defined as the surplus gain from a business activity or process. So, if measured in value, a person who invests $2 and makes it $5 by selling goods gains $3.
It is computed as follows:
Profit formula = total revenue – total expenses
The total expense of the whole business operations is deducted from the total revenue to determine the actual income generated by a firm.
In economics, it generally refers to money or cash generated by a business. But, in common parlance, it does not always refer to money.
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