When you speak to us (or other accountants), you probably hear a lot about profits and margins. When you go to seminars or read about business, you probably get bombarded with different names for profits and margins. If you find all that hard to follow, this is a simple guide to profit terms, how they fit together, and how you can use them to run your business better.
Why profit matters
Profit is when your revenue (or income) for a period is more than your expenses for the period. It means you’re coming out ahead. There are several types of profit that measure different aspects of your business: Gross Profit, Operating Profit, and Net Profit. Each of them reveal different information about your revenues and expenses. We explain them below.
If you aren’t making a profit, your business isn’t sustainable. Looking at the different types of profit highlights where you need to focus your attention. For example, if you aren’t even making a Gross Profit (Net Sales less the cost of producing your goods or services), you may be offering too many discounts and allowances, or your basic production and labour costs may be too high. If you’re making a Gross Profit but an Operating loss, your overheads could be too high. And if you’re making an Operating Profit but a net loss, it could mean you are paying too much interest on loans, or you aren’t planning for your taxes.
Understanding how each of the profits works gives you insight into your business you wouldn’t have otherwise. The Profit Flow diagram below shows how they interact.
How different profits are calculated and what they mean
For summary guidance on how the different profits are calculated and how you can use them to work on your business, download our one page SME Accounting Terms Guide – Profit.
If you have irregular revenue sources other than Sales, such as investment income, or from selling an asset, these are usually added back to Net Profit separately at the end. Doing this allows you to see how well your business is doing, independent of that other unrelated income.
Profit is measured in simple dollars, so it doesn’t take into account how much revenue you had to make to generate that profit. That’s where identifying margins can be helpful.
Next item in Beat Accountant Speak? Margins. These figures work closely with profit to guide you on improving business performance.
At Inline Partners we want to make it simple, and give you the tools to understand business numbers. If you need help making sense of your accounts, please book a free consultation with us.
