What types of profits exist in the economy

One of the main indicators of business development efficiency is the amount of revenue that an enterprise earns in a month, quarter, or year. However, there are more than twenty types of profit in the economy, each of which shows the success of one or more aspects of commercial activity. In order for a business to develop steadily, an entrepreneur must understand the main types of profits, understand what they consist of, what they affect and how to use them to achieve growth in the company’s economic indicators.

Profit, revenue, income: what is the difference

People who are far from business and economics often confuse these three concepts, because they see earned money in each of them. The concepts are similar, closely interrelated, but differ in essence.

Revenue refers to the funds that the entrepreneur received from the sale of the main product or service:

• if this is a bookstore, then the daily revenue is the money that has accumulated in the cash register by the end of the working day from the sale of books and magazines;
• if this is a coffee shop, then from the sale of coffee, cakes, pastries;
• if it is a transport company, then from the funds paid by the customer for the transported goods.

No expenses are taken into account when calculating it.

Income is a broader concept: it consists of revenue, as well as additional income that is not related to running the main business. For example, a company can rent out premises, sell unnecessary equipment, deposit money in a bank and receive interest. The income will include penalties paid by counterparties, dividends from participation in partner programs. All these receipts are revenue, but not revenue. The company’s income varies from month to month: it all depends on the amount of additional financial income. If there were none, then the monthly revenue will be equal to the income. 

Profit is the difference between income and expenses. It remains after all types of expenses, including taxes, interest on loans, are deducted from all types of income, so there is always less revenue and income. If the monthly expenses exceeded the income, it means that the company ended the reporting period with a loss, the profit in the accounting documentation will be marked as negative.

Why does a business need to understand the types of profit

Each type of profit shows only one side of business development:

• margin – how effective are the costs (if it has decreased, it’s time to look for new suppliers or cheaper raw materials);
• gross – the profitability of the production of a product (its decrease indicates that it is better to abandon it);
• accounting – financial success.

Therefore, according to one or two indicators (especially tracking only net profit), it is impossible to understand the true state of affairs and correct the situation, a comprehensive analysis of all types is needed.

Types of company profits

The main types are considered to be from revenue, from which various types of expenses are deducted.

Margin

This is the difference between revenue and direct variable expenses, which include cost of production:

• expenses for raw materials, components, spare parts for equipment;
• transportation;
• percentage of sales to sales managers.

Marginality illustrates how efficiently funds are spent, as well as whether shipment volumes are calculated correctly. If the indicators are low, it is necessary to raise prices or reduce costs.

Gross

In addition to variables, fixed costs are also taken into account when calculating gross profit:

• for the rental of premises;
• on salaries;
• utility payments.

There are fixed costs, even if the company does not work. However, with an increase in the volume of production, the share of costs in the cost price will decrease (provided that production does not expand).

Gross profit is the difference between revenue and the amount of expenses (temporary and permanent). Its importance for a certain type of product demonstrates the profitability of its production.

Operating room

When calculating operating profit from revenue, it is necessary to take away fixed, variable, as well as administrative and commercial expenses, which include expenses for:

• advertising, promotion;
• document management;
• connection;
• bank services.

This indicator illustrates the level of earnings before making mandatory payments on taxes and loans, and also helps to estimate the costs of activities not directly related to production.

Clean

This is the money remaining after deducting all expenses, expenses, payments of tax and debt obligations, as well as the cost of depreciation of equipment.

Net profit is an indicator of the company’s performance. Knowing it, an entrepreneur can adjust expenses, costs and prices, as well as make investment decisions.

Unallocated

This is the amount that has accumulated in the account because it has not been spent. Usually this money is spent on:

• company expansion;
• salary increase;
• investing;
• modernization of production.

Current

It shows the financial performance of an organization in a short period of time. It helps to assess the current success of the business, the opportunity to earn enough money to implement projects, as well as maintain operational activities.

Financial

This is the difference between the amount of income and expenses, including tax and credit payments, expressed in monetary terms. This indicator is important for evaluating the effectiveness of the company’s current activities.

Accounting

Reflects the financial condition of the company for a certain period. The calculation involves all types of income and expenses recorded in accounting, including depreciation, as well as deferred tax liabilities.

Economic

This is the most comprehensive indicator, taking into account explicit, implicit costs, as well as alternative (lost) ones. According to the indicators of economic profit, it is possible to judge the efficiency of spending available resources in comparison with alternative ones. A positive value indicates that the company generates revenue.

Functions of the received profit

The overall level of profit is used to judge the efficiency of an enterprise, its competitiveness, and the quality of goods and services. Different types of profit help to more accurately assess the profitability of individual areas in order to create a more detailed picture of the situation. There are also specific functions:

1. Stimulating, because it helps to identify the most promising areas of business development and discard unprofitable ones.
2. The controlling one. It helps to evaluate the company’s activities.
3. Reproductive. Shows the difference between the revenue and expenditure parts of the activity.
4. Fiscal, responsible for generating tax revenues to the state budget.

How to analyze profits

The purpose of the analysis is to identify the causes of changes in economic indicators and assess the effectiveness of resource allocation. You can conduct an analysis on your own or with the involvement of auditors, and perform calculations:

• for the entire period of the organization’s existence or only for a single period;
• across the entire company or one of the divisions.

The fact that the company has an income is insufficient evidence of success. Business efficiency consists of:

1. Positive changes in dynamics. The analysis is carried out by comparing achievements for a certain period in the current year with indicators for similar periods in previous years (month, quarter, half-year). The positive ratio of current indicators to previous ones indicates progress in business development.
2. A balanced business structure. The company’s revenues consist of core and ancillary activities. An effective business should receive most of its profits from its core business. If in the process of structural analysis (by comparing income from different types of activities) it turns out that more money comes from non-core items, which means that there is a bias in the work of the enterprise. Structural analysis allows you to find out the share of each structural unit, product, and single transaction in the overall structure.
3. Profitability, which characterizes the ratio of profitability to the resources spent.

The value of profit

For the development of the enterprise and the economy

The profit of any enterprise is the fundamental basis of its existence. It determines how effectively the company develops, manages resources, allows you to introduce new technologies, invest in research, and attract talented specialists.

Successfully developing factories create a stable economic platform for the state. These are new jobs, products necessary for society and the country, as well as taxes. A budget is formed from tax revenues, the funds of which go to the development of medicine, education, infrastructure, the introduction of technological, as well as social projects. As a result, the general welfare of citizens is growing, the economic and technological power of the country is increasing, and with them the influence of the state on the world stage.

For investing

Profit indicators reflect the strength of the financial condition of the enterprise, and for an outside investor it is also a parameter by which a decision on investing money is made. There are a number of metrics that help a broker determine the return on investment:

1. EBITDA is an indicator of all types of earnings of an organization before tax, interest deductions, and depreciation. An analysis of the capital structure, the equipment of the company, and its tax regime helps to identify its strongest positions within the industry.
2. The debt burden ratio indicates how dependent the firm is on creditors and whether it copes well with debt repayment.
3. The interest coverage ratio illustrates an organization’s ability to service its loans.
4. Free cash flow is the money remaining after the payment of all obligations, costs and capital expenditures, which can be used for various purposes without risk, for example:

• business expansion;
• dividend payments;
• salary increase for employees;
• modernization.

These metrics are calculated based on profit indicators. A company registered on the stock exchange is required to disclose financial information for an independent investment assessment of the sustainability and prospects of its development.

Ways to increase profits

Based on the definition, profit consists of income and expenses. Therefore, in order to increase it, we must try:

• reduce costs;
• increase income.

Ways to reduce costs

1. Optimization of production. The introduction of new types of equipment and technologies, as well as the involvement of qualified workers, will reduce the percentage of defects, the amount of waste, and increase productivity.
2. Do not accumulate too large volumes of raw materials, spare parts, and components in warehouses. There should be exactly as many raw materials as possible to recycle during working hours. This will reduce costs, as well as prevent losses that may occur as a result of spoilage, expiration date.
3. Do not take out too large loans, especially if money is required not all year round, but only during the seasons. It is better to take out several small loans than one large one and pay interest on it when the load on the production line is minimal.
4. The development of a logistics scheme will reduce the cost of transporting raw materials and finished products, as well as secure cargo.

Ways to increase income

1. To increase labor productivity by modernizing processes and hiring qualified personnel.
2. Raise prices.
3. Constantly expand the range.
4. To find and develop new sales markets.
5. Develop your own brand, constantly promote products, and advertise product lines.
6. Rent out all unused areas.
7. Rent out or sell unnecessary equipment.
8. Put some of the money in the bank at interest.
9. Participate in partner programs that help advertise each other’s products and services.

The types of profit in the economy are closely interrelated and are necessary to maintain the effective operation of companies, as well as strategic planning. Ultimately, it depends on the accuracy of their calculation and maintaining an optimal balance, whether the company will become profitable or will spend all its energy plugging financial holes.