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An MBA graduate or accountant that has a profound accounting and financial knowledge may be able to state a clear-cut distinction between the terms profits and profitability. For a businessperson, it is not that hard either. We know that any business stands strong in the market because of the profits it makes. When it comes to business growth and expansion, these two terms play an influential role in defining what’s suitable and what’s right for a company—whether the financial grounds or bookkeeping records are favorable or not. One thing is very clear, regardless of size, businesses need to track their profit margin in order to make wise financial decisions that are important in strategic terms.  

The Basic Difference—Profit vs. Profitability

Profit and profitability are two terms that are often used interchangeably, however, they are not the same. The interpretation of both terms is different and those who are able to interpret them correctly can expect to witness financial success of a company. To determine whether a company is financially sound or not, business owners and investors need to track the company’s profit from its profitability. To keep the business afloat, you need to ensure a smooth working capital and cut business costs and expenses as much as possible. In simplest terms, whatever amount is left after subtracting the total expenses from the total revenues is profit. Similarly, the profit margin is the ratio between the net income and total sales as it is measured as a ratio or percentage.

Defining a Company’s Profit

If we go deep into the application of calculating a company’s profits and you are a professional accountant or bookkeeper, it won’t be hard. You need to sum up or add the total revenues and subtract the total expenses to get the amount of total profit. The point is, profit is an absolute term and we have a simple formula for calculating it.

Total profit= Total revenue – Total expenses

Evaluating Profit in Business Perspective

When we evaluate the term in a business perspective, we know that a company’s core objective is always to make a profit. Without making a profit, no company can survive in the market for long. Obviously, what is earned is invested back into the business and a company will grow slowly and gradually. But, the point is, profit alone as a measure of success can be deceiving. There are different routes to calculating a profit margin and business owners need to note minor cost shifts. The bottom line is, your income statement shows you whether you are making a profit or not. If the results are negative figures, you need to cut or readjust your business expenses or costs in order to ensure a profit.

Defining Company’s Profitability

The application for calculating profitability is a bit more complicated than calculating a normal profit. It involves percentages or ratios which show that profitability is the measurement of profit. Business owners need to ensure that their profitability index is positive in order to yield enough profit to sustain and grow, especially when the market competition is intense. A business requires careful financial tracking and controlling.

Profitability is the degree to which a business yields a financial gain. Although the company may be showing or realizing a profit margin and figures may seem to be attractive initially, this doesn’t necessarily mean that the company is profitable. Profitability is matched and contrasted against many aspects of the business; you must learn the art of the game before calculating the exact profitability index for your firm. Since profitability is the relative amount (a ration or percentage), it shows or expresses a ration between profit and revenue. The formula for calculating profitability or profit margin can be:

Profitability= Profit/Revenue* 100


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About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.

 

 

Profit Margin sign

Undoubtedly, an organization is most interested in how much it is able to generate gross profits. By definition, profit margin is the total amount that a business generates when its revenues generated from the overall sales exceeds the total cost of the sales. Profit is important for a company for multiple reasons. It is common knowledge that the purpose of every small or big business is to make profits. Without profits, a company doesn’t survive because the employers would not be able to pay its employees, suppliers, and investors. Even if companies can pay them, they will not be able to invest in attractive projects because they would not have enough money. Interpreting profit margin is highly important for any company because most of its financial and non-financial decisions depends on its financial prosperity. Similarly, profit margin measures how successful a firm will be in its business of making profits on each dollar of sales.

Regardless of their size and operations, most companies rely on sales for tracking their sales revenues, but knowing the sales revenue alone does not clearly indicate how a company is performing financially. On the other hand, organizations also use bookkeeping as a source for analyzing how the company is performing in terms of its finances. Generally, companies keep track of their spending and revenue through bookkeeping. The major benefit of bookkeeping is that it allows you to make a meaningful financial comparison. A well-designed and comprehensive bookkeeping system allows organizations to analyze their overall business spending and revenue. To obtain a detailed analysis, data can grouped by years, quarters, months, and even weeks.

Profit margin is sometimes referred to as “net profit margin” which displays the big picture of organizational profitability. The formula to calculate profit margin is dividing the net income by revenues or simply dividing the net profits by sales. For instance, a company that has $400,000 in sales and $10,000 in monthly net income has a net profit margin of 25% = $10,000 / $400,000 = 0.025. This means that a company has 25% of net income for every dollar of sales. Two of the most widely used methods for interpreting profit margin are standalone and comparison analysis.

Standalone Alaysis

When determining standalone profits, managers and accountants analyze all the profits generated by a single firm which is usually their own firm. In other terms, only those values are generated that are generated from the organizational operations. The major benefit of analyzing profit margin from standalone method is that it allows finance managers to evaluate the independent value of the organization. The analysis provides an explicit image of the earning power of a business entity by incorporating its costs and revenues that are linked with the business. The standalone method of interpreting profit margins enables organizations to observe its complete financial health as if it constitutes a chain of totally independent organizational activities. 

Comparison Analysis

When discussing profitability from a broader perspective, a number of companies use percentages more frequently than raw facts and figures. In the hyper competitive business environment, you cannot rely only on a standalone analysis because you must have knowledge about the external business environment and how it is performing. In order to gain better knowledge, organizations frequently use percentages because it enables you to make a comparison among several companies.

While it is very useful to use profit margin to compare the financial performance of different companies, it is highly important that all of the companies being compared operate in a common industry and incorporate similar business models. The simple reason behind this logic is that organizations operating in diverse industries have implemented different business models with unique revenue streams. As a consequence, companies may have huge differences in profit margin which will be meaningless.

In both cases, the analysis will allow you to interpret the current standing of the business in terms of financial health. When an organization is able to get an accurate idea of its profitability, it will be able to discover ways to cut back on expenditures and enhance profitability. Additionally, when an organization is able to improve its profit margin, there will be less pressure and a better environment.

Check out America's Best Bookkeepers
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.