Profit refers the earnings from the business operations. It customarily means the bottom line of the business income statement or its profit and loss statement. For many business owners, it refers to the amount earned before income taxes are paid. However, this is not correct. It really means the amount earned for the owners of the business net of all costs and expenses.
The discrepancy relates to the various legal formats of businesses. Those entities that are tax pass-through entities do not pay income taxes at the business level, but pay those taxes at the investor level; thus the confusion with the definition of profit. In some business formats, it refers to the net income after taxes whereas in the pass-through entities, it refers to the net income before taxes are paid at the investor level. For a better understanding of pass-through entities, please read: Types of Business Entities.
Profit is often misused and misunderstood by even some of your more sophisticated businessmen. The problem is that the term is generic and to use it correctly it should be qualified. The following are the various different qualifiers:
- Net – refers to the bottom line earnings from a business operation after taxes in the traditional corporate format. In the tax pass-through formats, it refers to the bottom line prior to taxes which are paid at the investor (partners, members, beneficiaries etc.) level.
- Operating (EBIT) – identifies the amount earned before payment of taxes, interest, and/or other significant costs.
- Gross – this refers to sales less cost of the goods sold or services rendered.
- Direct – refers to sales less those costs directly related to the production of the item sold or the services rendered.
- Indirect – refers to sales less direct and indirect costs.
In general, net profit is used to determine the overall success of the business operation. For the common person; the greater the net profit, the greater the success of the business. This is not necessarily the case in all operations. The key are the goals of the business organization. Some organizations exist to serve society such as non-profit charitable institutions. Profit does not measure their success. Others are large corporations where profit is essential, but so is the long term continuity of business. In some operations, increased profits come at a cost of staff or the quality of their products or services. There is give and take in fulfilling all these various goals. In essence, profit is not the true measurement of success; it is merely one of the indicators of overall success.
In addition, profit is often sited based on an accounting cycle of some duration. A more astute businessman will desire to understand the trend of profit over several periods than to place absolute reliance on the current profit. In addition, several uncontrollable forces (economic conditions, change in demographics, weather, interest rates etc.) can greatly impact the profit calculation and therefore a reader of information should take into consideration these outside forces in evaluating profit.
For the purposes of the reader, profit refers to the financial return net of all costs and expenses to the owners of the business. It is best to use one of the qualifiers when using the term to be more definitive of the different meanings for the term ‘Profit’. Act on Knowledge.
Do you want to learn how to get returns like this?
Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.
There are four key principles used with value investing. Each is required. They are:
- Risk Reduction – Buy only high quality stocks;
- Intrinsic Value – The underlying assets and operations are of good quality and performance;
- Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
- Patience – Allow time to work for the investor.
If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above.
Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:
- Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
- Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
- Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.
Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:
- Lessons about value investing and the principles involved;
- Free webinars from the author following up the lessons;
- Charts, graphs, tutorials, templates and resources to use when you create your own pool;
- Access to existing pools and their respective data models along with buy/sell triggers;
- Follow along with the investment fund and its weekly updates;
- White papers addressing financial principles and proper interpretation methods; AND
- Some simple good advice.