Profit

What is Profit?

Profit is the amount of Earnings that exceed expenses for the period. Profit is one of the most important terms in business and finance. Profit is also called net Income. It’s the remaining amount that is left over after all the necessary and matched expenses are subtracted for the tenure.

Most essentially, it's the Factor or the financial reward that business people strive to receive. Net profits are what is left after we add up all the costs and subtract the total from its sales revenue. In most cases, profits are calculated after the company pays its Taxes.

Profit Formula

The Profit Formula is given as,

Calculation of Profit Formula

For illustration purpose, let's understand the profit formula by taking up a calculation-

Suppose, a retailer buys a watch in bulk for INR 200 each. He sells them for INR 300 each. What is the profit in percentage?

• Selling price of the watch= INR 300
• Cost price of the watch= INR 200

Profit of the watch

= Selling Price−Cost Price/Cost Price × 100

= 300-200/200 x 100

= 50%

Profit Measures

There are several different ways a firm can make a ‘profit.’ Some examples of different profit measures are:

1. Gross profit

The gross profit is the part of the revenue which is left after deducting the cost of service provided or making a product. The formula of finding the same is:

Gross Profit= Revenue - Cost of Goods Sold

Let's assume that company X has a revenue of 10,000 INR and spent 4,000 INR in producing goods. Then, the gross profit would be calculated as-

Gross profit= 10,000 INR (Revenue) - 4,000 INR (Cost of goods sold) Gross Profit= 6,000 INR

To better understand gross profit, the concept of revenue and cost of goods sold should be clear. The sale of goods gives you the exact revenue amount. On the other hand, the Cost of Goods Sold (COGS) is related to the expenditures that occur while producing the goods or services. Expenses like insurance, rent, office supplies, interest charges, and others are excluded.

Here is another example of Gross Profit:

Company G manufactures expensive sunglasses. The headquarters of the company is in Mumbai. Its sunglasses are distributed all across the country. After a year-long business, company G wants to calculate the gross profit.

The first step to do so is to determine the company's revenue. Revenue is the amount that the company has made, excluding the cost of production. Company G accumulated 850,000 INR as revenue.

Next, for calculating the cost of goods sold, company G added the total cost incurred in producing goods and other expenditures like labour wages, depreciation, factory overhead, materials, and storage. The COGS for company G turned out to be 650,000 INR.

Gross Profit for Company G= Revenue – Cost of Goods Sold Gross Profit for Company G= 850,000 INR - 650,000 INR Gross Profit for Company G= 200,000 INR

Another factor that goes hand in hand with the Gross Profit is the Gross Profit Margin. Here is how Gross Profit Margin (GPM) is calculated. When gross profit is simply expressed in percentage, it is known as Gross Profit Margin.

The formula for Gross Profit Margin is:

GPM= (Revenue - Cost of Goods Sold)/Revenue x 100

In company G's case, the gross profit margin is calculated hereunder.

Revenue= 850,000 INR Cost of Goods Sold= 650,000 INR GPM= 850,000 INR (Revenue) – 650,000 INR (Cost of Goods Sold)/ 850,000 INR (Revenue) x 100 GPM= 200,000 / 850, 000 x 100 INR GPM= 23.5%

Recap to this calculation - the gross profit of company G is 200,000 INR. The gross profit margin is 23.5%. The calculation is based on the revenue and Deduction of the cost of the goods sold.

2. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

EBITDA helps understand a company's cash flow and operating performance without influencing Accounting decisions, financing decisions, or tax rates. Precisely, EBITDA reflects the financial health of the company. If a company has a high EBITDA margin, it is considered that it can afford business debts and has high Baseline profitability.

All this brings down to one question: how is EBITDA calculated? As the name suggests, EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortisation. Companies often make different financial decisions that might happen in different tax environments. With EBITDA, financial performance calculation is easy, and it paints a clear picture of the company.

Usually, EBITDA is calculated on a 12 months Basis. This is why LTM (Last Twelve Months) appears at the end of EBITDA.

For calculating EBITDA, there are two formulas used:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization;

Or

EBITDA = EBIT + Depreciation + Amortization

We will first explain EBITDA with net income and then separately talk about EBIT.

Here are some examples of EBITDA:

Company M runs a small bakery. Total revenue collected is 1,000,000 INR, net income is 100,000 INR, interest expenses is 10,000 INR, tax is 25,000 INR, operation profit is 65,000 INR, depreciation is 10,000 INR, and amortization is 5,000 INR.

EBITDA = 100,000 (Net Income) + 10,000 (Interest) + 25,000 (Taxes) + 10,000 (Depreciation) + 5,000 (Amortization) INR EBITDA = 150,000 INR

3. EBIT (Earnings Before Interest and Taxes)

EBIT helps in understanding the strength of the core operations. The creditors and investors can grasp the company's profit quotient without looking into tax ramifications or the Capital structure.

EBIT is calculated in two ways

EBIT= Total Revenues – COGS (Cost of Goods and Services) – Operating Expenses

Or

EBIT= Net Income + Interest + Taxes

Here is the example of EBIT:

Rusy manufactures lawn care equipment for commercial purposes. The sales are calculated around 1,000,000 INR, CGS is 650,000 INR, operating expenses are 200,000 INR, interest expenses are 50,000 INR, income taxes are 10,000 INR, and net income are 90,000 INR. Rusy’s EBIT will amount to

EBIT= Net Income + Interest + Taxes EBIT= 90,000 (Net Income) + 50,000 (Interest Expenses) + 10,000 (Income Taxes) INR EBIT= 150,000 INR

4. EBT (Earnings Before Taxes) or Net Profit Before Tax

EBT evaluates a company's operating performance, excluding tax ramifications. This helps in recognising operating performance eradicating the variables based on taxes.

EBT has a couple of ways to calculate, like:

EBT = Sales Revenue – COGS – SG&A – Depreciation and Amortisation EBT = EBIT – Interest Expense EBT = Net Income + Interest Expense

or

EBT = Net Income + Taxes

Let's understand EBT with the help of an example.

Company B has sales revenue 1,000,000 INR, EBIT 150,000 INR, income tax expense 50,000 INR, net income 100,000 INR, interest expenses 50,000 INR. Here, EBT will amount to:

EBT = EBIT – Interest Expense EBT= 150,000 (EBIT) - 50,000 (Interest Expense) INR EBT= 100,000 INR

5. Earnings after Tax

After-tax earnings are the net income after taking away all expenses and income tax. Simply, the earnings after tax are the company's gross income minus taxes.

Earning After Tax= Revenue – COGS – Operating Expenses – Income Tax

Here is an example of Earning after Tax:

QPR runs a Manufacturing firm and has a revenue of 100,000. The cost of goods sold amounts to 35,000 INR, operating expenses 25,000 INR, income tax expenses 10,000 INR.

Earning After Tax= Revenue – COGS – Operating Expenses – Income Tax Earning After Tax= 100,000 (Revenue) – 35,000 (COGS) – 25,000 (Operating Expenses) – 10,000 (Income Tax) INR Earning After Tax= 30,000 INR

Virtually every company seeking investment and funding claims that they are successful. To check the exact state, the calculation of genuine profitability is essential. The measures mentioned above will do the same.

Faqs

Q.1. What is the difference between gross profit and net profit?

A: Gross profit is the profits earned after deducting the costs of producing, whereas net income is the company's profit after deducting all the expenses from revenue.

Q.2. What are the adjustments made to EBITDA?

A: Some common adjustments made to EBITDA are unrealized profit or loss, litigation expenses, non-cash expenses like depreciation and amortization.

Q.3. Is profit before tax and EBIT the same?

A: No, profit before tax accounts for interest, but EBIT doesn't.