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Profit

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Business Studies

Look for companies with high-profit margins."

- Warren Buffet

One of the main objectives of businesses is making a profit. But what exactly is profit? And what are the different types of profit? Let's find out.

The meaning of profit

Profit reflects a company's financial gain after the deduction of costs, taxes, and other expenses from its revenue.

The distribution of profits is decided by the owners of the company. They can determine whether to distribute the profit among themselves or to use it for the company's growth. Generally, a mature company's profits are distributed as dividends and that of a fairly new company are used for the company's growth.

What is gross profit?

Gross profit is the profit a company makes after reducing the amount of money spent on producing the product from the money made from selling the product.

This is the first level of profit.

Profit definition of gross profit StudySmarter

Sales - the amount of money generated by selling the product

Cost of goods sold - the total amount of money (cost) required to produce the product.

What is operating profit?

Operating profit is the profit after deducting operating expenses, and the amortisation and depreciation of assets from gross profit.

Operating profit is the second level of business profit. It includes the fixed cost and the variable cost.

Profit definition of operating profit StudySmarter

Operating expenses are the ongoing costs for running the business.

Depreciation is an actual decrease of the fair value of an asset, such as a machine used for production.

Amortisation is the action or process of gradually writing off the initial cost of an asset.

What is net profit?

Net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue.

It determines the overall profitability of the company and helps investors understand the effective management of the company. The net profit is commonly referred to as the profit of the company. This is the third level of profit.

Profit definition of net profit StudySmarter

Total revenue - total cash obtained by selling goods or services to buyers.

Total expense - total spending of a company.

All three types of profits are written in the company’s income statement.

Examples of profits

Let's look at some examples to help understand all of these terms.

Gross profit

When a company (ABC Furnitures Ltd.) makes a total sale of £700,000 by selling 50 wooden tables which cost them £20,000 for production, their gross profit is:

£700,000 (Sales) - £20,000 (Cost of goods sold) = £680,000 (Gross profit).

Operating profit

When the gross profit is £680,000, operating expenses are £15,000, and the amortisation (£5,000) and depreciation (£7,000) amount to £12,000, then the operating profit is:

£680,000 (Gross profit) - £15,000 (Operating expense) - £5,000 (Amortisation) - £7,000 (Depreciation) = £653,000 (Operating profit)

Net profit

Having an operating profit of £653,000, a total operating expense of £45,000, and tax expense of £23,000 the net profit is:

£653,000 (Operating profit) - £45,000 (Operating expense) - £23,000 (Tax expense) = £585,000 (Net profit)

Net profit is typically synonymous with net income.

An income statement with gross, operating, and net profits

Profit, Income statement, StudySmarterFigure 1. ABC Furniture's Income Statement, StudySmarter

Profit calculation is important, as it helps us in understanding the financial value of a company.

Profit - Key takeaways

  • Profit reflects a company’s financial gain after the deduction of costs, taxes, and other expenses from its revenue.
  • The profit reflected in a company’s income statement does not reflect the amount of extra cash generated by the company.

  • Gross profit is the profit a company makes after reducing the amount of money spent on producing the product from the money made from selling the product.

  • Gross profit = Sales - Cost of goods sold

  • Operating profit is the profit after deducting operating expenses, and the amortisation and depreciation of assets from gross profit.

  • Operating profit = Gross profit - Operating expense - Depreciation - Amortisation

  • The net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue, and helps investors to evaluate the company.
  • Net profit = Total revenue - Total expenses.

Profit

Profit means the money the company has generated is more than all the expenses spent on various activities of the company.  The profit statement shows the business performance and helps investors understand the company’s efficiency to grow. The profits are shown in the company’s income statement in three levels, and give information about a company’s performance.

Profit can be defined as the financial gain the company realises when its revenue exceeds the cost and expenses incurred to generate this revenue.

Gross profit is the first level of profit that the company generates. This is the residual value when the cost of goods sold is subtracted from the amount of money generated from sales. Gross profit = Sales - Cost of goods sold.

The net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue. This is the third level of profit.

Profit or Net profit = Total revenue - Total expenses

Final Profit Quiz

Question

Under which level of profits does the operating profit fall?

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Answer

The second level of profit

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How are profits used?

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Answer

Profits are either taken by the owners themselves or used towards the company’s growth. Generally, a mature company’s profits are distributed as dividends and that of a fairly new company is used for the company’s growth. 

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Question

Which level of profit is indicated by the gross profit?

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Answer

The first level of profit.

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Question

What is the definition of net profit and what is the formula to find it?

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Answer

The net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue. 

Net profit = Total revenue - Total expenses.

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Question

State the formula for calculating the operating profit.

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Answer

Operating profit = Gross profit - Operating expense - Depreciation - Amortisation.

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Question

Give an example of gross profit.

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Answer

When a company makes a total sale of €70,000 by selling 50 wooden tables which    cost them €20,000 for production, their gross profit is:

€70,000 (Sales) - €20,000 (Cost of goods sold) = €50,000 (Gross profit).

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Question

What is the formula for calculating gross profit?

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Answer

Gross profit = Sales - Cost of goods sold

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Question

Give an example of net profit.

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If a company has a total revenue of €500,000, and the total expenses of €240,000 ( Salary expense = €180,000, Operating expense = €52,000, Tax expense = €28,000), their net profit is:

€500,000 (Total revenue) - €240,000 (Total expense) = €260,000 (Net profit).

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Question

What is an example of operating profit?

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If a company has a gross profit of €300,000, operating expenses of €15,000, the amortisation is €20,000 and the depreciation of the required machinery is €10,000, then the operating profit is:

€300,000 (Gross profit) - €15,000 (Operating expense) - €20,000 (Amortisation) - €10,000 (Depreciation) = €255,000 (Operating profit).

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Question

Complete the formula.




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Answer

Total expenses

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Question

What is the formula for?



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Answer

Gross profit

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Question

Complete the formula.



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Depreciation

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Question

Net profit is higher than gross profit.

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Answer

True

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Question

___ is the profit a company makes after reducing the amount of money spent on producing the product from the money made from selling the product.

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Answer

Gross profit

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Question

Gross profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue.

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Answer

False

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Question

This type of profit is commonly referred to as the profit of the company. This is the third level of profit. What type of profit is it?


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Answer

Net profit

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This is is the action or process of gradually writing off the initial cost of an asset.

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Answer

Amortisation

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Operating profit is the ___ level of business profit. 


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Answer

second

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Question

Operating profit is lower than net profit.

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Answer

True

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Question

___ expenses are the ongoing costs for running the business.


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Answer

Operating

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Question

How many levels of profit are there?

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Answer

3

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Question

Gross profit considers tax.

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Answer

False

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Question

Depreciation is considered when calculating...

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Answer

operating profit.

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Question

Complete the formula.



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Answer

Gross profit

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