What Is Profit (and What It Isn’t)?
Profit is one of the most fundamental concepts in business, yet it’s often misunderstood. So what is it? Profit is what remains after a business subtracts its expenses from its revenue. However, not all profit is created equal, and entrepreneurs should be mindful of the different ways profit is measured.
Types of Profit
- Gross Profit – This is the revenue minus the cost of goods sold (COGS). It shows how much money is left after producing or purchasing the products you sell, but before considering other operating expenses. Measuring gross profit is particularly important for manufacturing businesses and those selling goods.
- Operating Profit – Also called EBIT (Earnings Before Interest and Taxes), this metric considers gross profit minus operating expenses like rent, payroll, and utilities.
- Net Profit – This is what’s left after all expenses, including taxes and interest, are deducted. It’s the final measure of profitability.
What Profit Is Not
- Revenue: Revenue is the total amount of money earned from sales before any expenses are deducted. High revenue does not necessarily mean a business is profitable.
- Cash Flow: Profit and cash flow are related but not the same. A business can be profitable on paper but still struggle with cash flow if revenue is tied up in receivables or inventory.
- Owner’s Salary: Profit does not automatically mean the owner gets paid. Entrepreneurs should ensure they account for their own salary as part of business expenses.
Why Profit Matters
Profit is critical because it ensures the sustainability and growth of a business. It allows for reinvestment in operations, employee compensation, expansion, and financial stability. Without profit, a business may struggle to cover expenses, secure financing, or plan for future growth.
A business with consistent profit can:
- Invest in better equipment, marketing, or new product development.
- Build a financial cushion for unexpected downturns.
- Offer raises and benefits to employees.
- Provide a return on investment to owners and investors.
How to Assess Profit as an Entrepreneur
Business owners should regularly review their financial statements to get a clear picture of profitability. Here’s how:
- Review the Income Statement – This document provides a breakdown of revenue, expenses, and different profit levels. Compare profit margins over time to spot trends.
- Consider Seasonality – If your business has peak and slow seasons, look at profitability over the year, not just monthly figures.
- Factor in Estimated Taxes – Many entrepreneurs forget that a portion of their profit will go to taxes. Set aside estimated tax payments throughout the year to avoid surprises.
- Analyze Pricing and Costs – Evaluate whether your pricing strategy is sustainable and whether costs can be optimized without sacrificing quality.
- Separate Business and Personal Finances – Ensure that personal withdrawals don’t distort profitability. Owner draws should be carefully tracked.
- Use Profitability Ratios – Metrics like net profit margin (Net Profit / Revenue) help assess efficiency and compare profitability over time.
Final Thoughts
Understanding and reviewing profit regularly is essential for making informed decisions and ensuring long-term success. Entrepreneurs should go beyond just looking at revenue and ensure that their business is truly profitable after all costs are considered. By keeping an eye on expenses, setting aside funds for taxes, and analyzing financial trends, business owners can build a stronger, more resilient company.