Here's the bottom line. Understanding the difference between gross profit, operating profit and net profit is essential for running a healthy, thriving business.

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Today, I wanna talk to you about the different types of profit. So, when it comes to running a business, one of the most important things you need to understand beyond cashflow because you know how much I love cashflow is profit, but not just profit in general, because there are different types of profit and each one will tell you something unique about how your business is performing. You've probably heard terms like gross profit, operating profit or net profit, but they could all be super confusing if you're not familiar with what they actually mean or how they differ. So today I'm going to break down these three types of profit in a way that makes sense and then show you why each one is so important to your business's success. By the end of all this, my goal for you is that you'll have a better understanding of how each type of profit impacts your financial health and why it's critical to understand where your money's coming from and where it's going. So let's go ahead and kick things off with gross profit. This is the most straightforward of the three.

Gross profit is essentially the money you're making from selling your products and services, after you subtract out the direct cost involved in producing or delivering it. These direct costs are known as cost of goods sold. So remember, on the income statement, at the very top we have revenue. That's your top line. That represents all the income that you're making by selling your products or services. And then you have to subtract out things like raw materials or labor or other expenses directly tied to creating your product or service. Those costs are known as cost of goods sold. So if you take revenue minus cost of goods sold, you arrive at gross profit. Think of it this way Gross profit is all about the core activity of your business selling your product or service and then incurring the cost in order to fulfill that product or service. It tells you if you're pricing things right and if your direct costs are in a good place. So here's the formula. Remember gross profit equals revenue minus your cost of goods sold. Here's why it matters. Gross profit gives you a clear view of whether your core business model is actually working. If you're making money after covering the direct costs, that's a great sign. If not, it might mean you need to revisit your pricing or look for ways to reduce production costs. A strong gross profit margin means you're efficiently managing these direct costs.

Now if you wanna know a range for gross profit and this is like so general okay, so don't hold me to this like very general, it's around 30 to 50%. I know that's a huge range, but I work with some companies and they have a 60% gross margin. I work with others that have an 80% gross margin and the others they have a 20% margin. Okay, so it doesn't really matter what your gross margin is, because we still have to account for your operating expense. And for some businesses they may have a 30% gross margin, but their operating expense is so low it's like 10% that they're still making 20% net margins, which we'll get into here in a. But the whole thing with gross profit is this it's gross profit, gross margin. It's the same thing, but when it comes to improving it.

So if you're looking at the financial statements and you notice your gross profit is taking a nosedive, there are three things you could do to improve it. Number one you can increase your volume. In other words, you could just sell more of your product and service, and this scale will help you to drive higher gross profits. Number two you can improve your cost efficiencies, in other words, your variable costs and costs. We had sold your material costs. You go negotiate better pricing with your suppliers, with your labor costs. You can use technology, you can train your labor force, you can give them better tools to be more productive, to increase your throughput and your production rates. So that's another thing you do. You could lower your cost. Or the third lever is you can increase your pricing. So those are the three things. Guess which one is the best? If you said pricing, you just won a prize with me because that's exactly right. Pricing typically is the biggest lever when it comes to improving profitability. Just remember that. So if you ever interview with me, I interview a lot of people CFOs, controllers, other financial people and guess what? Oftentimes they miss this question. Even the CFOs misses. They go on and they ramble about a bunch of random stuff. But just be very concise in your response. Three ways to increase gross profit Do more volume, reduce your costs costs we'd sold, that is or change your pricing. All right, there you go, all right.

Now that you have gross profit mastered right, that's my hope it's time to look at operating profit. This is where things start to get more specific. Operating profit takes your gross profit and then subtracts the cost of running your business on a daily basis. These are the expenses that keep the business operating, like rents, salaries, utilities and marketing expenses, just to name a few. Essentially, it's how much money you're making from your core business operations after covering these day-to-day costs. So here's the formula Operating profit equals your gross profit minus your operating expenses. Or, if you want to sound cool, opex or SG&A selling general and administrative expenses or overhead.

There's so many different ways to describe operating expenses. I like to use all the different terms so when you hear them in the real world, you're like yep, I know what you're talking about. Because in business, especially in finance, there's so many different terms which can confuse people unless you really understand financial statements. So that's why I like to share these different terms with you, so you can get used to hearing them All right. So operating profit this is why it matters. Operating profit is where your business's true core profitability comes from. It tells you if your day generate from the core operations of your business, which leads us in to the third type of profit. So finally, we come to net profit, the one that everyone wants to talk about when they hear profit.

This is the number that reflects your business's overall financial performance. Net profit is what's left over after all the expenses have been deducted, including your operating expenses, taxes, interest on debt and any one-time or non-operating cost. In other words, it's your operating profit minus other income and other expense that is not related to the core operations of your business. This is the number that tells you whether your business is truly profitable, after considering everything production cost, operational cost, other income, other expense, et cetera. Here's the formula Net profit equals operating profit plus other income minus other expense. And there you have it.

The reason why net profit matters is because it's the most comprehensive measure of your business's financial health. It shows you how much you're truly earning or losing. After all factors have been taken into account. This is the number you'll use to reinvest in your business, pay dividends or decide how to handle future financial strategies. Free cash flow is the most important metric, because net profit doesn't equal cash flow. That's really critical, but nonetheless, low or negative net profit can indicate that you need to cut costs, increase revenue or reassess how you're running your business. More importantly, it may mean that your strategy is terrible and it's not working, and you need to do things differently. So here's why you need to know these numbers. Here's the bottom line Understanding the difference between gross profit, operating profit and net profit is essential for running a healthy, thriving business.

Each one serves a different purpose and you don't want to sound like an idiot in front of people if you're mixing these terms. Years ago I took my wife to a tennis tournament the US Open in New York. She loves tennis. I don't know a whole lot about tennis. I know more about it now since we've been married. But when I went to the U S open, I have to laugh because I would say terms I'm like oh, yeah, you know they, they're hitting it across the line. She's like the baseline, that's the baseline. I was like, oh, I like how they run up to the net and they smack it down. She's like that's called a volley. And I was like, okay. But then I tried to use the terms later and it was totally out of context and, yeah, I probably sounded like a complete idiot. Okay, all right, so don't do that in business.

You wanna be confident, you wanna know the numbers, you wanna know what they're about. So let's do a quick recap, all right. So number one, gross profit, helps you to understand how well you're doing at the most basic level. Remember, it's calculated by taking your revenue, the income that you generate from selling your product or service, and then all the costs associated with fulfilling the product or service right. So it's gross profit. Gross profit is before overhead expenses.

Then we trickle down to the next level, which is operating profit, which shows you how efficiently you're managing the business as a whole. It's calculated by taking gross profit and subtracting out your overhead or your op-ex same thing operating expense. And then finally we arrive at net profit, which tells you how much of your revenue is actually turning into real profit. After all, expenses are accounted for. So, remember, net profit is calculated by taking operating profit and then accounting for those non-operating items. So you're adding back other income and you're subtracting out other expenses that are not core to operations.

So, altogether, these profits give you a full picture of your business's financial health and guide you towards smarter decisions, because if you have a problem with gross profit, you know what the levers are. I told you what they were before. You could just pinpoint those levers and then tackle them right away and guess what? You could be the star of the day, because you turn around your company and you make it more profitable. So, whether you're figuring out how to scale, where to cut costs or simply how to make your business more profitable. Knowing where your money is going and where it's coming from is super critical. All right, that's what I have for you today. I hope you enjoyed this episode. Be sure to share it with others If you found value in it. That would mean the world to me, and until next time, take care of yourself. Cheers.