Operating profit is the amount of return that remains when the operating costs associated with the same period are subtracted. Businesses usually calculate this figure in order to assure that the company is functioning in a manner that is likely to result in a profit when all expenses, including taxes, are paid. By subtracting standard operating costs from the gross profits, it is possible to determine if there is enough remaining to pay taxes, offset any depreciation or amortization that applies, and cover any other expenses related to the ongoing function of the business.
Sometimes known as EBIT, or Earnings Before Interest and Tax, the determination of operating profits can be a valuable tool in helping a business make the most of available resources, eliminate waste, and avoid unnecessary purchases as they relate to securing raw materials or stock for the company. When the amount of operating profit decreases from one period to the next, that is a warning sign that something has changed in the company operation or the consumer market that the business services. In either situation, knowing that the operating profit has declined provides business owners, managers, and others involved with the enterprise a chance to make changes and restore the former level of profitability.
There are several ways to enhance the operating profit margin of a company. The most obvious is to adjust the expenses associated with the day-to-day operations of the business. This can mean looking for new vendors who offer raw materials at lower unit prices, or streamlining the operation in a manner that cuts back on operating personnel. The company may also choose to discontinue production of products that offer very little in the way of profit while stepping up production of lines that are more profitable.
Another way to increase the gross operating profit of a business is to adjust the retail price of the goods produced. This may involve a slight increase in the unit price. However, it could also involve lowering the unit price slightly in hopes of generating higher volume. The higher volume may make it possible to in turn obtain volume discounts on the materials needed to produce the items and result in a higher return for the business overall. By adjusting the operating profit ratio to the cost of raw materials, the company may find itself in a much more enviable financial position than ever before.
By using an operating profit definition of revenue minus costs that are incurred during the operation cycle, it is also possible to obtain data that can allow the company to project changes in consumer buying habits and make adjustments before the new trend emerges. For example, if consumers are beginning to exhibit a conservative approach to purchasing goods produced by the company, noting the initial decrease can provoke an investigation into mitigating circumstances such as new technology or general economic conditions such as a recession. Identifying the underlying reasons for the change in the operating profit margin and moving to weather those short-term or long-term factors can make the difference between remaining in business or closing the doors forever.