Although profits and earnings sound like they could describe the same thing, they have different meanings in the business world. Earnings, for example, typically refers to the bottom line on a company’s income statement. Breaking it down further, a company’s net earnings describes the amount it takes in after accounting for all expenses. With net earnings, a company’s accountant can determine the earnings per share. This figure is useful for investors when deciding whether to purchase stock in the company.
Profit, on the other hand, describes three important figures on the income statement for a business. These figures include gross profit, net profit, and operating profit. While some people use the term earnings interchangeably to describe any of these functions, it’s more common to determine profit by considering these three factors individually.
Understanding the Different Types of Profit
The term gross profit describes the sales efficiency of a business. It considers only the direct expenses related to producing a product to sell for profit. A high gross profit means that the company is doing well in keeping production costs low while pricing the product as high as the market will bear at the same time.
By analyzing its operating profit, a company can determine how well it manages its indirect costs. The steps involved in determining operating profit include subtracting every indirect cost from the gross profit. Examples of indirect costs include administrative costs, marketing costs, and depreciation. This also helps the business owner to understand which endeavors ultimately help the business and which ones have a disappointing return on investment (ROI). Lastly, it’s useful in comparing the management of direct and indirect costs with producing a marketable item.
To calculate net profit, a company’s accountant should subtract taxes and interest from operating profit. These two items are the last considerations when calculating total earnings. Net profit enables businesses to calculate net profit margin, the most important figure for many investors.
Understanding Your Company’s Earnings
Earnings, also referred to as the bottom line, represent the amount your company has earned only after deducting all types of expenses. Some businesspeople also refer to it as net earnings, net income, or net profit. Most companies calculate earnings for a specified time period such as once per quarter and an annual report. This is also the time a business determines its value for earnings per share (EPS).
When reviewing your company’s balance sheet, net earnings should reflect as retained earnings and appear in the equity section. Retained earnings on the balance sheet refer to all retained earnings plus net income less dividends. Net earnings should appear in the operating activities section on the top line of the cash flow statement.
Have Additional Concerns About Managing Wealth as a Business Owner?
At Aura Wealth Advisors, we understand that it can be challenging to understand and differentiate between these terms. We invite you to schedule an appointment with an advisor to go over your company’s process to ensure you know exactly where it stands from a financial perspective. We can also answer your questions about other wealth management services for business owners at the same time.