This series will take you behind some of the metrics you should be measuring in your business, including: profit, accounts payable and receivable, inventory and payroll. We’ll talk about what they are, what they really mean and more.
Profit is almost certainly something you care about in your business. But what exactly is it? Bottom-line, profit is when you have more revenue (sales) than expenses.
Cash flow and profit are not the same thing; it’s possible to have one, but not the other.
Three Types of Profit
There’s more than one kind of profit. Or rather, there is more than one way to measure profit. These three types include gross profit, operating profit and net profit, and all three are found on your income statement.
- Gross Profit. This is your total revenue minus the cost of goods sold. In other words, it’s the amount of money you’re getting from your customers less the expenses it took to make your product or provide your service.
- Operating Profit. Operating profit is your profit from your core business functions. The difference between gross profit and operating profit is pretty straightforward: gross profit is a direct look at your revenue after expenses from sale, whereas operating profit looks at profitability after you account for your operating expenses (salaries, administrative costs, etc.).
- Net Profit. This is your “bottom line.” Net profit is how much profit you make after you take into account all of your revenue and expenses, such as investment income, income (or loss) from sale of property and equipment, interest income or expense, taxes, etc.
Revenue – Cost of Goods Sold = Gross Profit
Gross Profit – Operating Expenses = Operating Profit
Operating Profit ± Other Income & Expenses = Net Profit
Profit Margins
Along with your profit, it’s important to consider your profit margin. These profitability ratios help show the financial health of your business. Profit margins can be looked at as a trend (this year compared to last year, this month compared to last month, etc.), or you can benchmark yourself against similar companies to gain a better understanding of how you compare to your peers. By monitoring your profit margins, you can see if what you’re doing is working or if you need improvement. Furthermore, it will help you forecast (budget) your future revenues and expenses.
There are two types of profit margins:
- Gross Profit Margin. Gross profit margin looks at the percentage of revenue left over after you account for all of your costs of goods sold. It’s calculated by taking gross profit and dividing it by revenue. Your gross profit margin tells a story about how effectively and efficiently your business is producing your product or providing your service.
- Net Profit Margin. Net profit margin looks at the big-picture of your business and portrays the percentage of revenue that actually turns into profit. It’s calculated by dividing net profit by revenue. Net profit margin is particularly important for your business because it gives you a bottom-line view of your profitability and overall business health.
Profit and profit margins are among some of the most important metrics to track for your company. They give you a picture of where you’re currently at, what’s working and what’s not, and they can even show you where you could be headed in the future.
Accounting metrics are critical to your overall business strategy.
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