Have you ever heard of profit? What is profit? In business, profit is often called financial gain. The company must aim to get the maximum financial gain or profit. Moreover, profit is a significant component of a business.
Principally, profit is a core part of a company’s finances. Without a significant profit, a company will find it difficult to survive. Then what exactly is profit, and what are its types and elements? Have a look at the full explanation below!
What is Profit?
Profit meaning (source: Freepik)
Profit is the financial gain a company earns, which can be used to measure a company’s management level of success. Profit can also be seen as a company’s net income or the result of what the company does. However, a company could also use the profit to assess the risk of an investment.
There are many definitions of profit, according to several experts. Some of them include the definitions from the Indonesian Accounting Association: Charles Thomas Horngren, M. Nafarin, Don R. Hansen, and Maryanne M. Mowen. Still, a profit is usually defined as an amount of money that is more than what was spent to get that money or profit.
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Types of Profit
Indeed, in accounting, we learn about the types of profit. There are four types of profit components in accounting, namely:
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Gross Profit on Sales
The first type of profit is the gross profit on sales. This profit is measured by the difference between the cost of goods sold and net sales. It’s called “gross profit” because it doesn’t consider the company’s operating costs for a given period.
Operating Profit
The next part of the profit is operating profit, which is what’s left over after gross profit, production, administrative, tax, and selling costs are all taken out.
Profit before tax
Next, there is profit before tax, which is also known as earnings before taxes (EBIT). This profit is the sum of all company income before deducting corporate tax, or it is the difference between operating income and expense income, among others.
Profit after tax
The last type of profit is profit after tax. If it was previously net income before tax, this type is net income after tax. This profit is obtained from gross profit minus interest, taxes, and company operating costs.
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The Elements of Profit
Profit definition (source: Freepik)
Not only the types of profit, but also the elements of profit, should be learned due to their importance. The following are the elements of profit:
Income
The first element of profit is income. It’s the company’s inflows that occur in one period of accounting. Income is obtained from operational activities such as selling products or obtaining credit.
Expense
This element is the opposite of the income element. The expense is the money the company has to pay out after selling a product in one accounting period. During an accounting period, expenses usually lead to a drop in economic benefits or assets, which means equity often goes down.
Cost
This element is the company’s cash that is used to produce goods or services that provide profit for the company, since the nature of business is to make a greater profit. But if the costs have expired, this will be called an expense.
Profit and Loss
The next part is profit and loss, which is the amount by which the company’s equity goes down or up because of transactions that happen in the company during a certain period. However, it is not from the investment income of the company’s owner.
Net Income
The last element is net income. This is what happens when you subtract expenses and losses from the income and profits in one period.
Furthermore, it is also a gross inflow of economic benefits. These things happen as part of a company’s normal operations during a time when gross inflows cause an increase in equity that isn’t caused by the investment business.
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What are the Functions of Profit for the Company?
In general, profit is used to figure out taxes and figure out how much pay and bonuses to give to employees. Further, net income also serves as a tool to measure management’s achievement and as a basis for decision-making.
Profit can also be used to estimate what the company’s net income will be in the next accounting period. The income statement also has several benefits, including:
- 1. Distinguishing capital from profit
- 2. The estimated profit in the next accounting period serves as a measurement tool for achievement and a basis for decision-making.
- 3. The measurement tool of management performance
- 4. Providing information for dividend prediction
- 5. The calculation tool for tax
- 6. The benchmark of tax distribution, compensation, and employee bonus
In the end, profit is the amount of money made by the company’s activities, from making the product to selling it, minus all the costs that were necessary. After drawing conclusions and getting to know the definition of profit, its types, and elements, are you ready to start your own business and make as much profit as possible? Hopefully, the explanation above is worthwhile!
