Since the idea of becoming an entrepreneur came to your mind, you have thought about two things: how to better respond to the existing need on the market and how to make a profit. We have to tell them from the start that you have no chance of success if you were going to focus only on making a profit.
The time of “cannons” is over, now the consumer dictates who sells what and how much. The faster and better you understand the new way of doing things, the closer you get to your lucrative (and not blameworthy!) goal of making money.
Let’s assume, then, that you did everything by the book and built your business around these two goals. Let’s say you’ve identified a real consumer need and are honestly trying to fulfill it. How do you achieve, in turn, financial satisfaction? The road from dream to reality is long and strewn with dozens of obstacles, some of which you intuit, others that appear out of nowhere. What is profit, what are its components and how can you increase it, so you can rest assured that your business is going in the right direction? We take them one at a time because there is a lot to discuss.
WHAT IS PROFIT?
At the definitional level, the concept of profit is quite simple to understand: it is the difference between income and expenses. Basically, it represents the result of your commercial activity, an indicator of the effectiveness of your company, and proof that the means of production, financial, human, and material resources are used thoughtfully and rationally.
When we talk about profit, we operate with three concepts that make it up: gross profit, operating profit, and net profit. Each type of profit provides analysts with specific information about a company’s performance, especially when compared to competitors’ profits or that firm’s profits over other time periods.
TYPES OF PROFIT
GROSS PROFIT
This is an indicator of the annual production efficiency, without taking into account the expenses of the premises, taxes, and utilities. If you get a gross profit, you don’t necessarily have to rub your hands with joy. It’s just a sign that your product can support its own production costs, but at the end of the year, you can find that the company is not profitable in reality, due to other expenses.
Gross profit is calculated according to the following formula:
Gross profit = Revenue – Costs
To break down the formula, revenue comes from selling products, and costs are calculated by adding together fixed costs (such as the cost of a building) and variable costs (such as the cost of producing the products).
As I said, the gross profit is useful so that you can make a comparison between your company and others with the same object of activity on the market, but also to objectively analyze the performance of your company from one year to the next.
A lower gross profit than the previous year should raise questions. You can check if your sales volume has decreased, you may have calculated too low a price for your services or products, or your production costs have increased. A low gross profit can be a signal that you are working inefficiently and should invest in machinery or change something in the way production is organized. Once you’ve identified the problem, it will be much easier for you to establish a more coherent plan for making production more efficient.
OPERATING PROFIT
Gross profit refers to profitability after direct expenses, and operating profit refers to profitability after operating expenses.
Operating expenses are those generated by the company’s marketing, administrative and general actions (utility expenses and some salaries).
This kind of profit is a sign that you have an operationally successful company. It is controllable, but not entirely, because it also does not include interest expenses, fees, and taxes, amounts that you cannot fully anticipate.
It is not only important for you, as an entrepreneur, to know the operating profit. In case of a possible investment in your company, the financiers will ask you for these figures because they are relevant. The higher the operating profit, the clearer it is that there is demand for the products or services you sell, but also that they will invest in a company with a high degree of efficiency
Net profit
Net profit = Operating profit – Taxes, fees, and interest Only now you can really enjoy it! Net profit is the amount of money your company is left with after absolutely all expenses are subtracted. It’s your money that you can withdraw as dividends or reinvest to increase the efficiency of your company.