Gross Profit, Operating Profit and Net Profit: For an enterprise, profit is usually the primary target and a key measure of success. While financing through debt or equity can help a business sustain and grow, generating profit and ploughing them back into the business is important. For those without a source of capital or investors, profit perhaps is the only way to capitalise the business. Moreover, it also incentivises the management or promoter for a larger risk appetite and expansion.
Profit can primarily be categorized into gross profit, operating profit and net profit other than net operating profit after tax (NOPAT) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
Gross vs. Operating vs. Net Profit and NOPAT vs EBITDA – Key Differences
Gross profit or gross income is the profit earned by an enterprise after deducting all the costs incurred for manufacturing and selling its products or services. In other words, subtracting the cost of goods sold (COGS) from your total sales or total revenue gives you the company’s gross profit shown in the income statement.
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For example, a cycle maker sold 100 cycles for Rs 5 lakh in sales revenue after incurring Rs 2 lakh in expenses such as spares and labour costs. Here, the gross profit declared will be Rs 3 lakh.
COGS include depreciation, factory overhead, labour costs directly related to production, materials, storage, packing and shipping, etc., excluding fixed costs such as marketing, admin costs, rent, insurance, amortisation expenses, etc.
Operating profit is derived from the gross profit of the company and is an important indicator of a business’s health and efficiency in managing its expenses. Basically, it is the net income of a business earned from its core operations. Operating expenses are salaries, sales and marketing costs, rent, accounting and legal fees, utilities, office supplies, etc.
To calculate operating profit, operating expenses and day-to-day costs such as depreciation and amortisation are subtracted from gross profit. Taking the above example, if the gross profit of the cycle maker is Rs 3 lakh and his operating expenses and day-to-day costs are around Rs 1 lakh, his operating profit would be Rs 1 lakh.
Net profit also called as profit after tax (PAT), net income, net earnings, and bottom line as the name suggests is the money earned by a company after deducting all its expenses, interest and tax. It is the real indicator of the financial health of an enterprise and its ability to make more money and invest. It also serves as an important metric in raising a bank loan as higher net profit indicates cash flow strength and the business’s ability to repay the loan.
While operating profit is the remaining income of a company after deducted operating expenses, net profit is essentially residual income left after paying all costs incurred or deductions.
Continuing with the above example, the net profit for the cycle maker would be his operating profit of Rs 1 lakh minus interest and taxes worth let’s say Rs 45,000, which comes out to be Rs 55,000.
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On the other hand, NOPAT, in comparison to net profit, is derived on the operating income of a business to understand its operational efficiency. It is the income generated along with operating expenses less taxes and interest or operating income x (1 – tax rate). Similar to operating profit, NOPAT measures the profitability of a company’s core operations except the impact of financing and taxes.
To calculate, if the cycle maker’s operating income is Rs 1 lakh and the tax rate is 0.4 per cent, then NOPAT would be Rs 60,000.
Lastly, while NOPAT is calculated after accounting for taxes, EBITDA is calculated prior to tax payments. A quick way to compute EBITDA is to add depreciation and amortization back to earnings before interest and taxes as it was subtracted earlier to calculate operating income. The EBITDA margin indicates the extent to which the operating expenses are taking away the gross profit of the business.
One can calculate EBITDA by adding net income, interest, taxes, depreciation, and amortisation together or adding operating profit with depreciation and amortisation.
For example, the cycle maker’s net income of Rs 55,000 in addition to interest expense let’s say Rs 5,000, income tax of around Rs 4,500, depreciation of around Rs 15,000 and amortisation of around Rs 5,500 would give EBITDA of Rs 85,000.
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