Gross profit and operating profit are important calculations aimed at measuring the profitability levels of the firm. Both these numbers are derived from the information obtained from the company’s income statement. Gross profit shows the sales that are left once cost of goods sold are reduced and operating profit shows the revenue that is left over once all other expenses (including cost of goods sold) are reduced. The article clearly explains the two terms gross profit and operating profit and shows how they are similar and different to one another.
What is Gross Profit?
Gross profit is the amount of sales revenue that is left over once the cost of goods sold has been reduced. The gross profit provides an indication of the amount of money that is left over for making other operating expenses. Gross profit is calculated by deducting the cost of goods sold from net sales (this is the number that you get once the returned goods have been reduced from the total good sold). The costs of goods sold are expenses that are directly related to the manufacture of the goods that are sold. In the event that a business is a service provider then the cost of goods sold would become the cost of services rendered. Gross profit is usually used to calculate important ratios such as the gross profit ratio which tells the business owners whether the sales price charged compensates for the costs of selling incurred.
What is Operating Profit?
In simple terms, operating profit is the profit that a firm makes from its core/main operations. It must be kept in mind that an operating profit could, just as easily, be an operating loss too, depending on the kind of financial year that the firm had. A company’s operating profit is quite easy to calculate. It is calculated by subtracting the company’s total operating expenses for the year from the revenue. Examples of operational expenses include, cost of goods sold, overhead costs, marketing and sales costs, advertising/product promotion costs, funds paid on legal or business consulting, research and development costs, etc.
If a company generates a sizeable operating profit, this is an indication that the firm performs its core operations efficiently and effectively. If the firm makes an operating loss, this means that the company should evaluate its core business operations and cut down wastage, cost, and improve its revenue streams. A company’s operating profit does not, however, include extraordinary expenses or income that occurs outside the normal course of business. This may be items such as the cost incurred to build a new showroom, or the income that may have been received by selling off a large building. The reason why such items are not included is that they do not occur frequently and may mislead the management, investors, and shareholders with regard to the company’s future earnings prospects.
What is the difference between Gross Profit and Operating Profit?
Gross profit and operating profit are equally important since they measure a firm’s profitability. Gross profit shows the funds that are left over for making other expenses. Operating profit, on the other hand, shows the total profit that is made once all expenses have been reduced. The major difference between these two is that gross profit is calculated by reducing costs directly related to producing and selling the goods and services while operating profit is calculated by reducing all other expenses from the gross profit figure.
Summary:
Gross Profit vs Operating Profit
• Gross profit and operating profit are important calculations aimed at measuring the profitability levels of the firm.
• Gross profit is the amount of sales revenue that is left over once the cost of goods sold has been reduced.
• Operating profit is the profit that a firm makes from its core/main operations. It is calculated by subtracting the company’s total operating expenses for the year from the revenue.
• The major difference between these two is that gross profit is calculated by reducing costs directly related to producing and selling the goods and services while operating profit is calculated by reducing all other expenses from the gross profit figure.