Profit: One bottom line, a bunch of ways to get there
You made a profit? Which kind?
If I hear someone announce, “My business had $X for profit” or “We profited Y% last year,” my guess is that maybe they’re a new business owner. Or, that they’re not well versed in general business vocab. Or — worst-case scenario — that they really haven’t been paying attention to the business end of their business. Like, at all.
But, you ask, isn’t profit just the money left over at the end?
Sure, I say … the end of what?
The truth is this: There’s more than one path to profit, and all kinds of meanings for that word. So let’s take a look at its many possible definitions!
But first! Talking about business terms should be fun, so I’m giving you a hot dog stand. You are the proud new owner of <Insert Name Here>’s Hot Dogs! Take a second to imagine your favorite hot dog, get a little hungry, and then read on.
- Profit = revenue. Sometimes people say “profit,” and they mean their total revenue. This is *all the money* that came in from customers, regardless of costs. If you get $125 from selling hot dogs to customers, you’d say you had a total revenue of $125 — even if you spent $100 to get there.
- Profit = gross profit. This one is a little bit trickier. Gross profit is how much money you have left after you subtract the direct cost of a sale. So, if you sell a hot dog for $10, and it costs you $1 to buy it, your gross profit is $9. In this scenario, there’s a 1:1 relationship between making a sale and having a cost.
Rent, for example, is not included in gross profit, because it doesn’t have a 1:1 relationship with sales. (Whether you sell 10 hot dogs or 20, your rent is the same.) This version of the term is important because it tells you how well you’re selling the thing you sell — but not necessarily how you’re running the company as a whole.
- Profit = EBITA (Earnings before interest, taxes, and amortization; also sometimes called net operating income or NOI). This is what people mean most frequently when they say “profit.” This is how much money is left over after paying all of the ordinary operating costs that come with running a business. If you own a hot dog shop, it’s how much money you have left after buying hot dogs, paying rent, paying your employees, etc.
- Profit = net income. This is the very bottom-line number on your profit-and-loss statement. EBITA, above, only includes costs related to operating your business, but net income also includes non-operational costs, like paying interest on your loans.
Some people wonder why this bucket even exists. I mean, isn’t credit card interest a business expense? The answer is yes, absolutely. However, where it differs from other operating expenses is that it’s *optional.* You could stop paying it tomorrow if you just paid your credit card down to zero, and it would have zero impact on your business. It is, essentially, “the cost of money” — which is not a cost of running your business.
The reason for so many versions of the word profit is that each one allows you to look at the business through a slightly different lens to see where it’s going better — or worse — than expected.
Profit in practice
How do these terms work together? Grab a sticky note and write this down:
- If your revenue is too low, you need to sell more.
- If your gross profit is too low, you’re not charging enough OR you’re spending too much money on the direct cost of the sale. It’s time to start buying hot dogs for less or charging extra for pickles.
- If your EBITA is too low, but your gross profit is healthy, it’s a sign to take a look at operating expenses. It might be time to cut staff or find a cheaper place to rent.
- If your net income is too low, but your EBITA is healthy, that’s all about financing costs. If you’re paying too much credit card or loan interest, it might be a smart idea to repay a debt sooner rather than later.
When you become well versed on various forms of profit, it’s easy to see that if you’re paying too much for hot dogs, reducing your staff isn’t going to fix the problem. Or if you’re spending too much on interest, then moving to a new location won’t help the numbers.
Maybe having one word with a million nuances is a good thing. It’s like one of those pointillism paintings. Stepping back gives you the full picture, and zooming in lets you see where there’s too much brown and not enough red. So the next time someone talks about their profit, ask them – Which profit?
And then you can really get down to business.
Most people think they intuitively understand what profit is, but it's unlikely two people would define it the same way.