Profit Definition Plus Gross, Operating, and Net Profit Explained

What Is Profit?

Profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question.

Any profits earned funnel back to business owners, who choose to either pocket the cash, distribute it to shareholders as dividends, or reinvest it back into the business.

What Does Profit Tell You?

Profit is the money a business pulls in after accounting for all expenses. Whether it's a lemonade stand or a publicly-traded multinational company, the primary goal of any business is to earn money, therefore a business performance is based on profitability, in its various forms.

Some analysts are interested in top-line profitability, whereas others are interested in profitability before taxes and other expenses. Still others are only concerned with profitability after all expenses have been paid.

The three major types of profit are gross profit, operating profit, and net profit--all of which can be found on the income statement. Each profit type gives analysts more information about a company's performance, especially when it's compared to other competitors and time periods.

Gross, Operating, and Net Profit

The first level of profitability is gross profit, which is sales minus the cost of goods sold. Sales are the first line item on the income statement, and the cost of goods sold (COGS) is generally listed just below it:

Gross Profit = Revenues - COGS

For example, if Company A has $100,000 in sales and a COGS of $60,000, it means the gross profit is $40,000, or $100,000 minus $60,000. Divide gross profit by sales for the gross profit margin, which is 40%, or $40,000 divided by $100,000.

Operating profit removes operating expenses like overhead and other indirect costs as well as accounting costs like depreciation and amortization. It is sometimes referred to as earnings before interest and taxes, or EBIT.

Operating Profit = Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Depreciation & Amortization

Net profit furthermore removes the costs of interest and taxes paid by the business. Because it falls at the bottom of the income statement, it is sometimes referred to as the firm's "bottom line."

Net Profit = EBIT - Interest Expense - Taxes

The bottom line tells a company how profitable it was during a period and how much it has available for dividends and retained earnings. What's retained can be used to pay off debts, fund projects, or reinvest in the company.