December 16, 2024 • 12 mins
In this episode of Boosting Your Financial IQ, Steve dives deep into the three critical types of profit every business leader must understand.
Gross profit, operating profit, and net profit each hold the key to uncovering your business's financial health—and mastering them can set you apart in the boardroom and beyond. Discover how to decode these metrics, avoid common mistakes, and leverage the most powerful levers to improve profitability.
Ready to transform your financial know-how? Tune in and take your career—and business—to the next level.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
Here's the bottom line.
Understanding the differencebetween gross profit, operating
profit and net profit isessential for running a healthy,
thriving business.
Speaker 2 (00:08):
This is Boosting your Financial IQ, where I help
business professionals withfinancial responsibility to
elevate their careers and runprofitable companies.
My hope is that you'll applythese lessons to achieve your
greatest ambitions.
Cheers and enjoy.
Speaker 1 (00:23):
Today, I wanna talk to you about the different types
of profit.
So, when it comes to running abusiness, one of the most
important things you need tounderstand beyond cashflow
because you know how much I lovecashflow is profit, but not
just profit in general, becausethere are different types of
profit and each one will tellyou something unique about how
your business is performing.
(00:44):
You've probably heard termslike gross profit, operating
profit or net profit, but theycould all be super confusing if
you're not familiar with whatthey actually mean or how they
differ.
So today I'm going to breakdown these three types of profit
in a way that makes sense andthen show you why each one is so
important to your business'ssuccess.
(01:05):
By the end of all this, my goalfor you is that you'll have a
better understanding of how eachtype of profit impacts your
financial health and why it'scritical to understand where
your money's coming from andwhere it's going.
So let's go ahead and kickthings off with gross profit.
This is the moststraightforward of the three.
Gross profit is essentially themoney you're making from selling
(01:28):
your products and services,after you subtract out the
direct cost involved inproducing or delivering it.
These direct costs are known ascost of goods sold.
So remember, on the incomestatement, at the very top we
have revenue.
That's your top line.
That represents all the incomethat you're making by selling
your products or services.
And then you have to subtractout things like raw materials or
(01:52):
labor or other expensesdirectly tied to creating your
product or service.
Those costs are known as costof goods sold.
So if you take revenue minuscost of goods sold, you arrive
at gross profit.
Think of it this way Grossprofit is all about the core
activity of your businessselling your product or service
(02:13):
and then incurring the cost inorder to fulfill that product or
service.
It tells you if you're pricingthings right and if your direct
costs are in a good place.
So here's the formula.
Remember gross profit equalsrevenue minus your cost of goods
sold.
Here's why it matters.
Gross profit gives you a clearview of whether your core
(02:34):
business model is actuallyworking.
If you're making money aftercovering the direct costs,
that's a great sign.
If not, it might mean you needto revisit your pricing or look
for ways to reduce productioncosts.
A strong gross profit marginmeans you're efficiently
managing these direct costs.
Now if you wanna know a rangefor gross profit and this is
(02:54):
like so general okay, so don'thold me to this like very
general, it's around 30 to 50%.
I know that's a huge range, butI work with some companies and
they have a 60% gross margin.
I work with others that have an80% gross margin and the others
they have a 20% margin.
Okay, so it doesn't reallymatter what your gross margin is
, because we still have toaccount for your operating
(03:16):
expense.
And for some businesses theymay have a 30% gross margin, but
their operating expense is solow it's like 10% that they're
still making 20% net margins,which we'll get into here in a.
But the whole thing with grossprofit is this it's gross profit
, gross margin.
It's the same thing, but whenit comes to improving it.
So if you're looking at thefinancial statements and you
(03:38):
notice your gross profit istaking a nosedive, there are
three things you could do toimprove it.
Number one you can increaseyour volume.
In other words, you could justsell more of your product and
service, and this scale willhelp you to drive higher gross
profits.
Number two you can improve yourcost efficiencies, in other
words, your variable costs andcosts.
(03:59):
We had sold your material costs.
You go negotiate better pricingwith your suppliers, with your
labor costs.
You can use technology, you cantrain your labor force, you can
give them better tools to bemore productive, to increase
your throughput and yourproduction rates.
So that's another thing you do.
You could lower your cost.
Or the third lever is you canincrease your pricing.
(04:21):
So those are the three things.
Guess which one is the best?
If you said pricing, you justwon a prize with me because
that's exactly right.
Pricing typically is thebiggest lever when it comes to
improving profitability.
Just remember that.
So if you ever interview withme, I interview a lot of people
CFOs, controllers, otherfinancial people and guess what?
(04:43):
Oftentimes they miss thisquestion.
Even the CFOs misses.
They go on and they rambleabout a bunch of random stuff.
But just be very concise inyour response.
Three ways to increase grossprofit Do more volume, reduce
your costs costs we'd sold, thatis or change your pricing.
All right, there you go, allright.
Now that you have gross profitmastered right, that's my hope
(05:05):
it's time to look at operatingprofit.
This is where things start toget more specific.
Operating profit takes yourgross profit and then subtracts
the cost of running yourbusiness on a daily basis.
These are the expenses thatkeep the business operating,
like rents, salaries, utilitiesand marketing expenses, just to
(05:26):
name a few.
Essentially, it's how muchmoney you're making from your
core business operations aftercovering these day-to-day costs.
So here's the formula Operatingprofit equals your gross profit
minus your operating expenses.
Or, if you want to sound cool,opex or SG&A selling general and
administrative expenses oroverhead.
(05:48):
There's so many different waysto describe operating expenses.
I like to use all the differentterms so when you hear them in
the real world, you're like yep,I know what you're talking
about.
Because in business, especiallyin finance, there's so many
different terms which canconfuse people unless you really
understand financial statements.
So that's why I like to sharethese different terms with you,
so you can get used to hearingthem All right.
(06:08):
So operating profit this is whyit matters.
Operating profit is where yourbusiness's true core
(06:37):
profitability comes from.
It tells you if your daygenerate from the core
operations of your business,which leads us in to the third
type of profit.
So finally, we come to netprofit, the one that everyone
wants to talk about when theyhear profit.
This is the number that reflectsyour business's overall
financial performance.
Net profit is what's left overafter all the expenses have been
(07:02):
deducted, including youroperating expenses, taxes,
interest on debt and anyone-time or non-operating cost.
In other words, it's youroperating profit minus other
income and other expense that isnot related to the core
operations of your business.
This is the number that tellsyou whether your business is
truly profitable, afterconsidering everything
(07:23):
production cost, operationalcost, other income, other
expense, et cetera.
Here's the formula Net profitequals operating profit plus
other income minus other expense.
And there you have it.
The reason why net profitmatters is because it's the most
comprehensive measure of yourbusiness's financial health.
(07:43):
It shows you how much you'retruly earning or losing.
After all factors have beentaken into account.
This is the number you'll useto reinvest in your business,
pay dividends or decide how tohandle future financial
strategies.
Free cash flow is the mostimportant metric, because net
profit doesn't equal cash flow.
That's really critical, butnonetheless, low or negative net
(08:06):
profit can indicate that youneed to cut costs, increase
revenue or reassess how you'rerunning your business.
More importantly, it may meanthat your strategy is terrible
and it's not working, and youneed to do things differently.
So here's why you need to knowthese numbers.
Here's the bottom lineUnderstanding the difference
between gross profit, operatingprofit and net profit is
(08:27):
essential for running a healthy,thriving business.
Each one serves a differentpurpose and you don't want to
sound like an idiot in front ofpeople if you're mixing these
terms.
Years ago I took my wife to atennis tournament the US Open in
New York.
She loves tennis.
I don't know a whole lot abouttennis.
I know more about it now sincewe've been married.
But when I went to the U S open, I have to laugh because I
(08:50):
would say terms I'm like oh,yeah, you know they, they're
hitting it across the line.
She's like the baseline, that'sthe baseline.
I was like, oh, I like how theyrun up to the net and they
smack it down.
She's like that's called avolley.
And I was like, okay.
But then I tried to use theterms later and it was totally
out of context and, yeah, Iprobably sounded like a complete
idiot.
Okay, all right, so don't dothat in business.
(09:10):
You wanna be confident, youwanna know the numbers, you
wanna know what they're about.
So let's do a quick recap, allright.
So number one, gross profit,helps you to understand how well
you're doing at the most basiclevel.
Remember, it's calculated bytaking your revenue, the income
that you generate from sellingyour product or service, and
then all the costs associatedwith fulfilling the product or
(09:30):
service right.
So it's gross profit.
Gross profit is before overheadexpenses.
Then we trickle down to the nextlevel, which is operating
profit, which shows you howefficiently you're managing the
business as a whole.
It's calculated by taking grossprofit and subtracting out your
overhead or your op-ex samething operating expense.
And then finally we arrive atnet profit, which tells you how
(09:54):
much of your revenue is actuallyturning into real profit.
After all, expenses areaccounted for.
So, remember, net profit iscalculated by taking operating
profit and then accounting forthose non-operating items.
So you're adding back otherincome and you're subtracting
out other expenses that are notcore to operations.
(10:14):
So, altogether, these profitsgive you a full picture of your
business's financial health andguide you towards smarter
decisions, because if you have aproblem with gross profit, you
know what the levers are.
I told you what they werebefore.
You could just pinpoint thoselevers and then tackle them
right away and guess what?
You could be the star of theday, because you turn around
your company and you make itmore profitable.
So, whether you're figuring outhow to scale, where to cut
(10:37):
costs or simply how to make yourbusiness more profitable.
Knowing where your money isgoing and where it's coming from
is super critical.
All right, that's what I havefor you today.
I hope you enjoyed this episode.
Be sure to share it with othersIf you found value in it.
That would mean the world to me, and until next time, take care
of yourself.
Cheers.
Here's the bottom line.
Understanding the differencebetween gross profit, operating
profit and net profit isessential for running a healthy,
thriving business.
Speaker 2 (00:08):
This is Boosting your Financial IQ, where I help
business professionals withfinancial responsibility to
elevate their careers and runprofitable companies.
My hope is that you'll applythese lessons to achieve your
greatest ambitions.
Cheers and enjoy.
Speaker 1 (00:23):
Today, I wanna talk to you about the different types
of profit.
So, when it comes to running abusiness, one of the most
important things you need tounderstand beyond cashflow
because you know how much I lovecashflow is profit, but not
just profit in general, becausethere are different types of
profit and each one will tellyou something unique about how
your business is performing.
(00:44):
You've probably heard termslike gross profit, operating
profit or net profit, but theycould all be super confusing if
you're not familiar with whatthey actually mean or how they
differ.
So today I'm going to breakdown these three types of profit
in a way that makes sense andthen show you why each one is so
important to your business'ssuccess.
(01:05):
By the end of all this, my goalfor you is that you'll have a
better understanding of how eachtype of profit impacts your
financial health and why it'scritical to understand where
your money's coming from andwhere it's going.
So let's go ahead and kickthings off with gross profit.
This is the moststraightforward of the three.
Gross profit is essentially themoney you're making from selling
(01:28):
your products and services,after you subtract out the
direct cost involved inproducing or delivering it.
These direct costs are known ascost of goods sold.
So remember, on the incomestatement, at the very top we
have revenue.
That's your top line.
That represents all the incomethat you're making by selling
your products or services.
And then you have to subtractout things like raw materials or
(01:52):
labor or other expensesdirectly tied to creating your
product or service.
Those costs are known as costof goods sold.
So if you take revenue minuscost of goods sold, you arrive
at gross profit.
Think of it this way Grossprofit is all about the core
activity of your businessselling your product or service
(02:13):
and then incurring the cost inorder to fulfill that product or
service.
It tells you if you're pricingthings right and if your direct
costs are in a good place.
So here's the formula.
Remember gross profit equalsrevenue minus your cost of goods
sold.
Here's why it matters.
Gross profit gives you a clearview of whether your core
(02:34):
business model is actuallyworking.
If you're making money aftercovering the direct costs,
that's a great sign.
If not, it might mean you needto revisit your pricing or look
for ways to reduce productioncosts.
A strong gross profit marginmeans you're efficiently
managing these direct costs.
Now if you wanna know a rangefor gross profit and this is
(02:54):
like so general okay, so don'thold me to this like very
general, it's around 30 to 50%.
I know that's a huge range, butI work with some companies and
they have a 60% gross margin.
I work with others that have an80% gross margin and the others
they have a 20% margin.
Okay, so it doesn't reallymatter what your gross margin is
, because we still have toaccount for your operating
(03:16):
expense.
And for some businesses theymay have a 30% gross margin, but
their operating expense is solow it's like 10% that they're
still making 20% net margins,which we'll get into here in a.
But the whole thing with grossprofit is this it's gross profit
, gross margin.
It's the same thing, but whenit comes to improving it.
So if you're looking at thefinancial statements and you
(03:38):
notice your gross profit istaking a nosedive, there are
three things you could do toimprove it.
Number one you can increaseyour volume.
In other words, you could justsell more of your product and
service, and this scale willhelp you to drive higher gross
profits.
Number two you can improve yourcost efficiencies, in other
words, your variable costs andcosts.
(03:59):
We had sold your material costs.
You go negotiate better pricingwith your suppliers, with your
labor costs.
You can use technology, you cantrain your labor force, you can
give them better tools to bemore productive, to increase
your throughput and yourproduction rates.
So that's another thing you do.
You could lower your cost.
Or the third lever is you canincrease your pricing.
(04:21):
So those are the three things.
Guess which one is the best?
If you said pricing, you justwon a prize with me because
that's exactly right.
Pricing typically is thebiggest lever when it comes to
improving profitability.
Just remember that.
So if you ever interview withme, I interview a lot of people
CFOs, controllers, otherfinancial people and guess what?
(04:43):
Oftentimes they miss thisquestion.
Even the CFOs misses.
They go on and they rambleabout a bunch of random stuff.
But just be very concise inyour response.
Three ways to increase grossprofit Do more volume, reduce
your costs costs we'd sold, thatis or change your pricing.
All right, there you go, allright.
Now that you have gross profitmastered right, that's my hope
(05:05):
it's time to look at operatingprofit.
This is where things start toget more specific.
Operating profit takes yourgross profit and then subtracts
the cost of running yourbusiness on a daily basis.
These are the expenses thatkeep the business operating,
like rents, salaries, utilitiesand marketing expenses, just to
(05:26):
name a few.
Essentially, it's how muchmoney you're making from your
core business operations aftercovering these day-to-day costs.
So here's the formula Operatingprofit equals your gross profit
minus your operating expenses.
Or, if you want to sound cool,opex or SG&A selling general and
administrative expenses oroverhead.
(05:48):
There's so many different waysto describe operating expenses.
I like to use all the differentterms so when you hear them in
the real world, you're like yep,I know what you're talking
about.
Because in business, especiallyin finance, there's so many
different terms which canconfuse people unless you really
understand financial statements.
So that's why I like to sharethese different terms with you,
so you can get used to hearingthem All right.
(06:08):
So operating profit this is whyit matters.
Operating profit is where yourbusiness's true core
(06:37):
profitability comes from.
It tells you if your daygenerate from the core
operations of your business,which leads us in to the third
type of profit.
So finally, we come to netprofit, the one that everyone
wants to talk about when theyhear profit.
This is the number that reflectsyour business's overall
financial performance.
Net profit is what's left overafter all the expenses have been
(07:02):
deducted, including youroperating expenses, taxes,
interest on debt and anyone-time or non-operating cost.
In other words, it's youroperating profit minus other
income and other expense that isnot related to the core
operations of your business.
This is the number that tellsyou whether your business is
truly profitable, afterconsidering everything
(07:23):
production cost, operationalcost, other income, other
expense, et cetera.
Here's the formula Net profitequals operating profit plus
other income minus other expense.
And there you have it.
The reason why net profitmatters is because it's the most
comprehensive measure of yourbusiness's financial health.
(07:43):
It shows you how much you'retruly earning or losing.
After all factors have beentaken into account.
This is the number you'll useto reinvest in your business,
pay dividends or decide how tohandle future financial
strategies.
Free cash flow is the mostimportant metric, because net
profit doesn't equal cash flow.
That's really critical, butnonetheless, low or negative net
(08:06):
profit can indicate that youneed to cut costs, increase
revenue or reassess how you'rerunning your business.
More importantly, it may meanthat your strategy is terrible
and it's not working, and youneed to do things differently.
So here's why you need to knowthese numbers.
Here's the bottom lineUnderstanding the difference
between gross profit, operatingprofit and net profit is
(08:27):
essential for running a healthy,thriving business.
Each one serves a differentpurpose and you don't want to
sound like an idiot in front ofpeople if you're mixing these
terms.
Years ago I took my wife to atennis tournament the US Open in
New York.
She loves tennis.
I don't know a whole lot abouttennis.
I know more about it now sincewe've been married.
But when I went to the U S open, I have to laugh because I
(08:50):
would say terms I'm like oh,yeah, you know they, they're
hitting it across the line.
She's like the baseline, that'sthe baseline.
I was like, oh, I like how theyrun up to the net and they
smack it down.
She's like that's called avolley.
And I was like, okay.
But then I tried to use theterms later and it was totally
out of context and, yeah, Iprobably sounded like a complete
idiot.
Okay, all right, so don't dothat in business.
(09:10):
You wanna be confident, youwanna know the numbers, you
wanna know what they're about.
So let's do a quick recap, allright.
So number one, gross profit,helps you to understand how well
you're doing at the most basiclevel.
Remember, it's calculated bytaking your revenue, the income
that you generate from sellingyour product or service, and
then all the costs associatedwith fulfilling the product or
(09:30):
service right.
So it's gross profit.
Gross profit is before overheadexpenses.
Then we trickle down to the nextlevel, which is operating
profit, which shows you howefficiently you're managing the
business as a whole.
It's calculated by taking grossprofit and subtracting out your
overhead or your op-ex samething operating expense.
And then finally we arrive atnet profit, which tells you how
(09:54):
much of your revenue is actuallyturning into real profit.
After all, expenses areaccounted for.
So, remember, net profit iscalculated by taking operating
profit and then accounting forthose non-operating items.
So you're adding back otherincome and you're subtracting
out other expenses that are notcore to operations.
(10:14):
So, altogether, these profitsgive you a full picture of your
business's financial health andguide you towards smarter
decisions, because if you have aproblem with gross profit, you
know what the levers are.
I told you what they werebefore.
You could just pinpoint thoselevers and then tackle them
right away and guess what?
You could be the star of theday, because you turn around
your company and you make itmore profitable.
So, whether you're figuring outhow to scale, where to cut
(10:37):
costs or simply how to make yourbusiness more profitable.
Knowing where your money isgoing and where it's coming from
is super critical.
All right, that's what I havefor you today.
I hope you enjoyed this episode.
Be sure to share it with othersIf you found value in it.
That would mean the world to me, and until next time, take care
of yourself.
Cheers.
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