What it means
At its simplest, profit is revenue minus expenses. If a bakery sells $50,000 of bread in a month and spends $42,000 on flour, staff, rent and everything else, it made $8,000 of profit.
In practice, managers look at profit in layers, and gross profit subtracts only the direct cost of what was sold. Operating profit then subtracts running costs such as salaries, rent and marketing, and net profit is what remains after interest and tax as well.
Each layer answers a different question. Gross profit tells you whether your product or service is priced well against its direct cost.
Operating profit tells you whether the business as a whole is run efficiently, and net profit tells you what is actually left for the owners. Profit is not the same as cash.
A business records profit when it earns revenue, even if the customer has not paid yet, which is why a company can report a healthy profit and still struggle to pay its bills at the end of the month. Profit is also more useful as a percentage than as a single figure.
A $100,000 profit on $400,000 of sales is a 25% margin, while the same profit on $5 million of sales is only 2%. The margin tells you how much room you have if costs rise or prices fall.
Finally, profit is an accounting measure built on judgements. Choices about depreciation, stock valuation and when to recognise revenue can move reported profit up or down, so looking at profit alongside cash flow gives a truer picture.
In practice
Real-world examples.
Example
A catering company earns $600,000 in revenue, spends $360,000 on food and kitchen staff, and $180,000 on rent, admin and marketing. Its operating profit is $60,000, a 10% operating margin.
Example
A freelance designer bills $120,000 a year and spends $18,000 on software, equipment and a shared office. Her profit before tax is $102,000, which is what she actually earns from the business.
Example
A retailer reports a $250,000 profit, but $180,000 of that is stock still sitting in the warehouse and invoices customers have not yet paid. Profit is up, yet the bank balance barely moved.
Formula
Calculation
Profit = Revenue minus Expenses
Gross Profit = Revenue minus Cost of Goods Sold
Operating Profit = Gross Profit minus Operating Expenses
Net Profit = Operating Profit minus Interest minus Tax
Worked example. A furniture workshop's year looks like this:
- Revenue: $900,000
- Cost of goods sold (timber, fittings, workshop labour): $540,000
- Gross profit: $900,000 - $540,000 = $360,000 (40% gross margin)
- Operating expenses (rent, office staff, marketing): $250,000
- Operating profit: $360,000 - $250,000 = $110,000 (12.2% operating margin)
- Interest on loans: $20,000
- Tax: $18,000
- Net profit: $110,000 - $20,000 - $18,000 = $72,000 (8% net margin)
Every layer is positive, but the gap between the 40% gross margin and the 8% net margin shows how much of each sale is absorbed by overheads, interest and tax. In dollar terms, $288,000 of the $360,000 gross profit, or 80%, is consumed before it reaches the owners.Case study
Seen in the real world.
This illustrative and entirely fictional example follows Harbour Lane Coffee, an invented chain of three cafes. The owner celebrated a record year: revenue up 30% to $1.3 million. Yet when the accountant presented the results, net profit had fallen from $95,000 to $41,000. The new third cafe had opened with high rent and a larger team, and heavy discounting had been used to build traffic. Revenue grew, but costs grew faster.
The owner cut the loss-making promotions, renegotiated two supplier contracts and reset staff rosters to match footfall. Within a year net profit recovered to $110,000 on slightly lower revenue. The owner also began reviewing gross, operating and net profit for each cafe every month instead of once a year. That showed which site was losing money after rent and which was carrying the group, so decisions about hours, menus and promotions could be made while there was still time to act.
Watch out
Common mistakes.
- Treating revenue growth as profit growth. Sales can rise while profit falls if costs or discounts grow faster.
- Confusing profit with cash in the bank. Unpaid invoices and unsold stock count towards profit but cannot pay the rent.
- Looking only at the bottom line. Checking gross, operating and net profit separately shows where the money is actually being lost.
Questions
People also ask.
What is the difference between profit and revenue?
Revenue is everything customers pay you. Profit is what remains after all the costs of earning that revenue are subtracted.
Can a business be profitable but run out of cash?
Yes. If customers pay slowly or money is tied up in stock, reported profit can be healthy while the bank account runs dry.
What is a good profit margin?
It depends heavily on the industry. Grocery stores may run on 2% to 3% net margins, while software companies can exceed 20%, so compare against similar businesses.
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