Generally, there are three types of profits in business, which are gross profit, operating profit, and net profit. However, net profit can be broken down into profit before and after tax. In this article, we discussed five types of profit in business.
1. Gross profit
This profit in business is earned after deducting direct costs from revenue. Note that income is divided into revenue and gains. Revenue is the income from regular business activities. Gains are income from any other business activities that are not part of the normal business activities.
For example, if a business sells cars, then the sale of a car is revenue. However, if the business decides to sell the car of the managing director to replace it with a better one, the income derived is gains. The knowledge of this will help you as you read further.
For gross profit, the direct cost can also be referred to as the cost of sales or production. This depends on the type of entity. Service firms use direct costs, trading entities use cost of sales, and the term cost of production is used by manufacturing companies. In the statement of profit or loss, gross profit is the third line item. That is, the first line item is revenue, the next is cost of sales.
2. Operating profit
This is gross profit plus other income less operating expenses (or OPEX). Other income like gains from the disposal of non-current assets and gains from foreign currency translation. Note that not all other income goes to the statement of profit or loss. Some might be found in the statement of other comprehensive income. The operating expenses might include, but are not limited to, salaries and wages, rent, transport, depreciation, and utility bills.
In the statement of profit or loss, operating profit is seen before interest charges. If a company is on loan, the interest charges will be deducted from the available income after OPEX. This is because a company is not expected to pay interest on a loan when it has not met its daily expenses. However, when there is no interest on the loan, the operating profit equals the net profit.
3. Net profit
This is the remaining profit after all expenses have been deducted from income. Simply put, it is income less expenses. Net profit is the bottom-line item in the statement of profit or loss. In fact, it is at times referred to as the "bottom line.” Here, interest on loan charges will have been deducted as well as any other expenses that cannot be regarded as OPEX. Net profit is divided into profit before tax and profit after taxation.
4. Profit before tax
This is the net profit before deducting taxation. The taxation here is company income tax. VAT and Withholding tax are usually included in operating expenses. Showing this as a line item helps the financial statement analyst to understand the actual profit made before considering the tax expenses that will go to the government. It is also a sign that the company is tax-compliant.
5. Profit after tax
A profit earned after deducting corporate tax. This profit is what the executive management will use to decide whether a company will expand or pay out dividends. Profit after tax serves as a return for shareholders' investment. The return on investment and earnings per share is computed from the profit after tax.
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