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Business profit is the amount remaining after expenses have been subtracted from the income of the business within a specified period of time. The period of time could be stated in monthly, quarterly, or annual terms. Types of profit include gross profit, net profit, and retained profit.
The first type of business profit is called gross profit, which is the excess of revenue from sales less the amount of direct costs — costs to create the products or prepare them for sale. This is referred to as cost of goods sold. These costs could include the materials purchased to manufacture products, transportation of materials into the production facility, direct labor to produce them, and distribution costs. The easiest way to determine cost of goods sold is to start with the value of the beginning inventory, add the amount of purchases during the period in question, and then subtract the value of the ending inventory.
Net profit is the difference between gross profit and operating expenses. Operating expenses differ from direct expenses because they are general business expenses that cannot be directly attributed to the products that are being sold. This is sometimes called overhead expense.
Operating expenses are expenditures that companies make in performing normal business activities. They are divided into two categories: selling expenses and administrative expenses. These include such things as sales commissions, depreciation expense, rent, management or office personnel salaries, repairs, office supplies, business licenses, and taxes. Business profit is usually discussed in terms of net profit since it is from this type of profit that owners receive their income or stockholders receive dividends.
Retained profit is the surplus profit after the amount is withdrawn by the owner or dividends are paid to stockholders. This amount is added to the owner’s equity or net worth of the business. Business profit is important because without it the company might cease to exist. Retained profit is important to the growth of the business and can be used for activities like adding a production line, increasing the size or number of facilities, or research and development of new products.
Owners or managers of companies keep track of business profit by completing a profit and loss statement. This financial statement begins with total or gross sales, less any discounts or returns. Then the cost of goods sold is subtracted to determine gross profit.
Operating expenses are subtracted from gross profit to show income from operations. From this figure, other revenue, such as dividends, interest, or rent income, is added and other expenses, such as interest and taxes, are subtracted to arrive at net profit. After any owner disbursements or stockholder dividends are subtracted, the remaining amount of the business profit will be retained profit.