What's the Difference Between Profitability and Profit?

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Definition:

Profit is how much money you’ve made after expenses, while profitability measures how sustainable your ability to generate profits is over time.

🤔 Understanding profit vs profitability

People often confuse profit with profitability. These accounting metrics are actually two different ways to analyze a company’s financial success. Profit measures how much money your business has left after you pay all of your costs (total revenue minus total expenses). Profitability measures profit over a defined period using key business metrics, in order to determine if your company is generating enough profit now to be successful in the future. Companies typically look to three metrics to track profitability: net profit margin ratio, operating profit margin ratio, and return on investment ratio.

Example

Let’s say you run an independent bookstore, and this month you’ve brought in $5,000 in revenue and paid $3,000 in expenses. That means your profit for the month is $2,000. If you want to look at your bookstore’s long-term profitability, you can use a more specific metric like the profit margin ratio.

You can work out a net profit margin ratio by dividing your profit by your revenue. In this case, that would be $2,000 divided by $5,000 – leaving you with a net profit margin of 0.4, or 40%. That means for every dollar you earn, you’re getting to keep 40 cents.

As a general rule of thumb, a profit margin of over 10% is considered about average – So your bookstore is not only generating profit, but also appears to be profitable.

Takeaway

Measuring profit and profitability is like measuring inches versus miles…

Working out your company’s profit is like measuring success in inches because it only tells you how far you’ve gone in the short-term. Working out your company’s profitability is more like measuring success by the mile. That’s because profitability looks at your profit over time to give you a sense of whether your company’s ability to generate profits is sustainable in the long run.

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What is the difference between profitability and profit?

The terms “profit” and “profitability” are often used interchangeably, but they’re two different accounting metrics.

Most businesses are founded to generate profit. Profit measures how much money your business has left over after you’ve paid all expenses. You can calculate this by working out all of the income, or revenue, you’ve made and then subtracting all of your fixed and variable expenses.

Unlike profit, profitability is relative — It can go up or down based on the value of the numbers it’s comparing.

Profitability uses one of several ratios to look at your company’s profit over time, in order to give you an idea of how sustainable that profit will be.

Common metrics you can use to figure out a company’s profitability include net profit margin ratio, operating profit margin ratio, and return on investment (ROI) ratio. By looking at these or other key profitability measures, you can figure out whether a business is likely to be successful in the long run.

For example, let’s say you own and operate a hot dog stand in the park. One Sunday, you make $500 in sales and spend $200 on meat, fixings, and a permit. Your daily profit is $300 ($500 in sales minus $200 in costs).

But is $300 for a day’s work good or bad? Profitability helps add context to your profit.

To see how efficient your hot dog stand is at making money, you can calculate your profitability using net profit margin. To do this, divide your profit ($300) by your revenue ($500). You’ll be left with a net profit of 0.6 or 60%, which means you’re earning 60 cents of profit for every dollar you make. Your hot dog stand is not only turning a daily profit, but is also likely to remain profitable in the long-term under these conditions.

What is profit?

Profit measures how much money your company makes after paying all of its expenses. The two types of profit businesses typically look at are gross profit and net profit.

Gross profit is how much money your company has earned after subtracting the cost of goods sold (COGS). COGS is the amount you need to spend directly to make your products or offer your services. By subtracting COGS from your business revenue, you’ll be able to calculate your gross profit.

Net profit — sometimes called net income or the “bottom line” — takes this concept a step further. Instead of only deducting COGS, net profit also subtracts all of your operating expenses, interest, tax liabilities, and any other costs your business incurs. By removing all of these expenses alongside COGS from your revenue, you’ll arrive at your net profit.

Your net profit is only referred to as “profit” if that number is positive. If you subtract all your expenses and end up with a negative number, it's called a “net loss.”

What is profitability?

Profitability is an accounting metric companies use to analyze the efficiency or sustainability of their profit levels.

Rather than simply look at how much money a business makes after expenses, profitability compares profit to overall sales, expenses, and other factors. This helps you gain a better idea of whether the profit you're generating is worth the amount of time, money, or energy you’re putting into the business.

You can track profitability using several different metrics or ratios. Three of the most common include net profit margin ratio, operating profit margin ratio, and return on investment (ROI) ratio.

Net profit margin looks at how much net profit a company makes for each dollar of revenue. Operating profit margin measures the profitability of your company’s operations before taxes and interest. This metric is also sometimes called an earnings before interest and tax (EBIT) margin. The ROI ratio explores how much money you’ve made or lost compared to the amount you invested.

Profitability ratios are most helpful for comparing a company’s performance to earlier periods or to that of similar companies.

How do you calculate profitability?

Profitability can be calculated using a few different metrics. These are generally either margin ratios or return ratios.

Margin ratios

Margin ratios look at a company’s ability to turn sales into a profit. The most popular margin ratio companies use is a profit margin ratio.

To calculate this, subtract expenses from your revenue and then divide the result by your revenue. You end up with the number of cents per dollar earned that the business keeps as profit.

Another type of margin ratio is cash flow margin. You can calculate cash flow margin by dividing a company’s cash flow from operating activities by net sales. Cash flow is the net amount of money flowing in and out of your company. Net sales is the amount of money a company makes from all sales after you subtract all of the company’s returns, allowances, and discounts.

You can also look at your earnings before interest, taxes, depreciation, and amortization (EBITDA) margin. The difference between profit margin and EBITDA is that EBITDA takes into account production and operating expenses, but adds back in depreciation and amortization. You can figure out EBITDA margin by subtracting all expenses apart from interest, taxes, depreciation, and amortization from your revenue, and then dividing by your revenue.

Return ratios

Return ratios look at the returns companies can generate for owners. Popular methods include calculating a company’s return on assets (ROA), return on equity (ROE), and return on investment (ROI).

You can calculate ROA by dividing your company’s net income by its average total asset value. Average total asset value is assets at the end of this year minus assets at the end of last year, divided by two. Don’t just use the current value of assets, because they can appreciate or depreciate (go up or down in value) over time.

You can calculate ROE by dividing your company’s net income by shareholders’ equity, which is how much the business’s assets are worth after subtracting your liabilities.

ROI is calculated by dividing your net profit by the total amount you’ve invested.

What is profit margin?

Profit margin is a metric companies use to measure profitability. It’s a quick way to figure out how much profit you’re earning per dollar of revenue.

For instance, If you’ve got a profit margin of 15%, that means you’re making 15 cents of profit for every dollar in sales.

There are three types of profit margin analysts normally use when working out profitability: gross profit margin, operating profit margin, and net profit margin.

Gross profit margin is the most general measurement of profit. It looks at the amount of money you’ve earned relative to revenue after subtracting the cost of goods sold (COGS).

Gross profit margin = (Revenue – COGS )/ Revenue x 100

An operating profit margin is also called an earnings before interest and tax (EBIT) margin. This metric looks at how much profit you’re left with after subtracting COGS and all of the operational expenses you need to pay before taxes. Those expenses might include things like wages, utility bills for brick-and-mortar stores, rent, and more.

Operating profit margin = Operating profit / Revenue x 100

Net profit margin is the most comprehensive measurement of profit margin. It takes your revenue and subtracts COGS, operating expenses, taxes, interest, and any other business expenses to get net profit, before dividing that by revenue. As a result, net profit margin gives you the best possible idea of how much money your business has made after all costs.

Net profit margin = (Revenue – Expenses)/ Revenue x 100

How important is profitability?

Knowing the profitability of your business helps you determine how sustainable your profits are.

It can be misleading to compare the profits generated by two competitors, because profit doesn’t look at other factors like sales and expenses. For example, let’s say two car companies generate the same levels of profit, but one of the companies has more employees. That means it will also have higher overhead expenses, and so will be more vulnerable to price changes.

Profitability can help companies figure out where they are vulnerable and explore which areas of the business need work. For example, in calculating a net profit margin ratio, you may find there are particular operating expenses you can cut.

Finally, profitability is an important measure if you’re looking to attract investors. Public companies often report their profit margins and ratios like EBITDA to demonstrate to potential shareholders that their business generates a sustainable profit – and that part of that profit can potentially come back to shareholders in the form of dividends.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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