What Is Profit – Meaning, Types, And How To Calculate

Key Takeaways

• Profit is the earnings a business keeps after paying expenses, and generating profit is the key goal of most businesses. If a business generates profit, then it can invest in growth and improve its market competitiveness.
   
• Businesses use profit to gauge success, and shareholders rely on it to judge whether the company is a good investment.
   
• Mainly, there are four types of profit: gross profit, net profit, operating profit, and retained profits, all types are created to serve particular objectives.

Profit is the extra money a business makes after paying all its costs, and it is the reward for the time, effort, and risk that owners take to run a business.

Suppose you operate a clothing store in Vasant Kunj, Delhi, which generates total sales of ₹24,00,000 in the financial year 2024-25. You spend a total of ₹15,00,000 on fabric, tailoring wages, rent, and electricity, and your total profit for the financial year 2024-25 is:

Profit = ₹24,00,000 - ₹15,00,000 = ₹9,00,000.

This ₹9,00,000 is the money you earned after meeting all expenses; now you can use this extra money to save, reinvest, or pay off debts. This article delves into the concept of profit, explores its various classifications, and examines the methods through which it can be calculated.

Types Of Profit

Calculating profit across different stages allows businesses to analyse financial performance with greater precision. Profit can be categorised into four main types, where each type represents a different stage of a business’s earnings.

1. Gross Profit

This is the profit left after subtracting the direct cost of making or buying goods from sales income; also, it does not include rent, admin salaries, or marketing costs.

Formula:

Gross Profit = Sales Revenue − Cost of Goods Sold (COGS)

The cost of goods sold (COGS) includes raw material costs, production expenses, and product purchases.

This can be better comprehended through a practical example involving an IT company. The following table summarises the revenue, COGS, and resulting profit of an IT company for three consecutive months:
 

Bonus Tip: Gross profit focuses only on direct production costs, which makes it useful for pricing decisions.

2. Operating Profit

Operating profit is also called Earnings Before Interest and Taxes (EBIT), and it is the profit after deducting operating expenses such as salaries, rent, and utilities from gross profit.

Formula:

Operating Profit = Gross Profit − Operating Expenses

To illustrate more clearly, we will continue with the IT company example introduced above:
 

Bonus Tip: Operating profit shows the efficiency of daily operations, ignoring interest and taxes.

Read More – How to Calculate Profit Percentage – Formula & Examples

3. Net Profit

This is the final amount after subtracting all expenses, including taxes and loan interest, and it is the figure that truly shows the financial success of a business.

Formula:

Net Profit = Operating Profit − (Interest + Taxes)

To illustrate more clearly, we will continue with the IT company example introduced above:
 

Note: The category ‘other expenses’ in the above table comprises taxes, interest, and related costs

Bonus Tip: Net profit is what truly counts for shareholders, as it reflects the real earning potential after all obligations.

4. Retained Profit

This is the portion of net profit kept in the business instead of being distributed as dividends; also, it is used for reinvestment and growth.

The total net profit in the above-mentioned example of an IT company is ₹62,000, and if they decide to distribute ₹22,000 as dividends, then their retained profit will be:

Retained profit = ₹62,000 - ₹22,000 = ₹40,000.

How To Calculate Profit?

The following is the standard method to calculate profit, which helps businesses understand how much money they retain after covering all costs and expenses:

Profit = Revenue – Expenses

Where:

Revenue: These are the earnings a business generates from selling its goods or providing services, which form the main source of income and help cover costs and generate profit.

Expenses: All costs involved in running the business, including production, salaries, rent, and taxes.

If you are managing a bakery, the table below summarises its earnings, expenses, and profit for FY 2023-24:
 

The above-mentioned table summarises your bakery’s profit journey from revenue to final net profit.

Also Read -What is an Income Statement? Format, Purpose & Key Terms

Importance Of Profit In Business

Profit is more than just a number, it drives real action within a business. The following table highlights importance of profit in business decision-making: 
 

From the table mentioned above, you can see that profit supports every critical decision, from expansion to employee rewards. If you understand it properly, then you can make better decisions and strengthen the overall performance of your business.

Final Thoughts

A profit indicates if your business is earning more than its expenditures. It serves as a key indicator of your business’s success. If you keep a track of your business’s gross, operating, net, and retained profit, then you can spot where money comes in and where it goes out.

A step-by-step profit calculation helps you understand business performance clearly and prevents confusion. A strong profit gives your business the means to expand, pay off liabilities, and tackle obstacles.

FAQs

1. What is depreciation?

It is the reduction in value of an asset over time due to use or wear and tear.

2. What is EBITDA?

It indicates the company’s earnings before taking out interest, taxes, depreciation, and amortisation costs.

3. What is a P&L?

It presents a comprehensive record of income, expenditures, and net profit over a set period, which allows businesses to track performance accurately.

4. What is a trial balance?

This report details all ledger entries, which allows verification that total debits correspond with total credits.

5. What is a 100% profit margin?

This term refers to selling a product for twice its cost price, meaning if an item costs ₹500 to make, it would be sold for ₹1,000, showing a 100% markup.

6. What is the journal?

It is a book or record where all financial transactions are first recorded in chronological order.

7. What is liquidity?

It is the ability of a business to quickly convert assets into cash to meet short-term obligations.

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