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Gross profit and operating profit are two measures of profitability in a company, calculated using information from the income statement. Gross profit represents gross sales minus costs of goods sold, while operating profit is total revenue minus expenses and taxes. Companies use these figures to analyze their profitability over time and compare with industry standards, but they can be manipulated by false accounting reports.
Two measures of profitability in a company are gross profit and operating profit. Each takes information from a company’s income statement. Gross profit represents a company’s gross sales for a period of time less related costs of goods sold. Businesses can use net income for this calculation, which is gross sales receipts minus any rebates, discounts, or bonuses. Operating profit is total revenue minus cost of goods sold, expenses, and taxes for a specified period.
Gross profit and operating profit provide an analysis for each end of the income statement. Gross profit measures the top numbers of a company. Total revenue represents gross sales resulting from goods and services sold to consumers. This helps a business track the cost of goods used to produce products. Operating profit measures the amount of net income a company earns after all expenses, which is the money a company can reinvest in the business.
Companies often calculate both gross profit and operating profit figures during their financial analysis. For example, a company has $500,000 US dollars (USD) in total sales and $350,000 in cost of goods sold. The company’s gross profit is $150,000 USD. An alternative to this formula is to divide the gross profit of $150,000 USD by the total revenue. The company has a 30 percent gross profit margin, which means that $.30 of every dollar goes toward cost of goods sold.
Operating profit has a similar formula. A company with $500,000 in sales and $350,000 in cost of goods sold also has $100,000 in expenses. The company’s operating profit is $50,000 USD. Dividing the $50,000 USD by total sales shows an operating profit of 10 percent of total sales. This provides a relationship between a company’s gross profit and operating profit.
Companies often calculate their gross profit and operating profit figures for various periods. This provides a historical trend that companies can use to gauge their profitability. The trend can also provide an indicator of whether the company is experiencing an increase or decrease in earnings. The number is also a benchmark for comparison with the industry standard or the leading company in the industry.
Gross profit and operating profit calculations are not without their flaws. Both figures use accounting numbers, which can be subject to manipulation by companies. False or incorrect accounting reports result in skewed profit percentages. This can lead owners and managers to make inappropriate decisions based on this information.
Smart Asset.
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