Profitability vs. Profit: Differences and Similarities
Updated February 3, 2023
Profitability and profit are two key measurements that can help businesses understand their success and long-term sustainability. Learning about the primary differences between profit and profitability can help you determine the success of your operations. It can also assist you in optimizing the business for which you work.
In this article, we compare profit versus profitability by defining both terms, listing their similarities and differences and showing the benefits of calculating each.
What is profit?
Profit is the amount of money that you earn from a business venture after subtracting any expenses. You can use multiple income sources to generate profit, including product sales, advertisement revenue and investments. When a business earns more money than it spends to continue operating, it accumulates profit. You can measure profit by reviewing income and expense statements, generating an absolute number for total profit or profit per unit.
What is profitability?
Profitability is a measure of your company's ability to earn profits. It is usually a fraction, ratio or percentage instead of an absolute number. This is because profitability is a comparison of several business factors within your company. If two similar businesses both earn profit from their operations but one earns significantly more profit compared to its expenses, that business has higher profitability.
There are three common methods for calculating profitability:
Profit margin ratio: Total profits compared to total expenses
Gross margin ratio: Revenue from products sold compared to manufacturing costs
Return on investment ratio: Profits compared to the amount of investments in the company
Related: A Guide to Profitability Ratios
Profitability versus profit
Though profitability and profit measure different aspects of business success, they have some key similarities and differences.
Similarities between profitability and profit
Here are the similarities between the two terms:
They rely on total earnings and expenses
Calculating both profitability and profit usually requires you to know your total earnings and business expenses. This helps make sure your final calculations give you an accurate understanding of both aspects of a business. The amount of income you are and the amount of money you spend influence both the profits you earn and your rate of profitability.
They help measure your success
To understand a company's success, it's helpful to understand both how much profit it generates. You can also use profitability metrics to understand the extent of your success and the meaning of profit calculations in the context of the entire company. Regularly tracking the amount of profit you earn and the overall profitability of a company can help you identify trends in business success and develop a strategic financial plan for the business.
Differences between profitability and profit
Here are the key differences between these two concepts:
Depth of focus
Profit primarily emphasizes your company's total earnings after operating costs. Knowing your profit helps you understand how much money you have to spend, invest in the business or distribute as dividends. Profitability has a deeper focus that outlines what your profit calculations mean, including which initiatives generate the most profit, how much you must spend to earn profit and how you can earn a higher percentage of profit from different income sources.
You can calculate business profits to determine how much money a business has at any given moment. Often, this is at the end of a financial quarter or year. You may calculate the cumulative profits of a business over its entire lifetime or the amount of profit you earn in a single day. Profitability addresses a business's long-term performance and may involve reporting information from several years to identify growth.
Related: How To Analyze Profit Margin Results
Benefits of calculating profit
Understanding your profit can have some of the following benefits:
Sustaining your business operations
The money your company earns can help you continue to pay expenses. By calculating profits, you can understand how much money you can spend to continue producing, marketing and selling products to your customers. Having an accurate record of profits provides you with a guide to developing an accurate operations budget.
Promoting business expansion
When you know how much profit your company earns, you can decide how to reinvest that money within your business. Knowing how much money you have to spend can help you know whether you can afford to invest in expansion initiatives like:
Hiring more employees
Purchasing improved technology and machinery
Constructing new facilities
Planning research and development projects
Reporting to stakeholders
Stakeholders typically want to know current business profits to track the sustainability and success of their investment. Calculating your profits can help you create reports to show investors the results of their financial commitment. Investors and stakeholders may also use profit information to share suggestions on how to spend the leftover income after paying for business expenses.
Limitations of calculating profit
Though your profit helps you understand your current finances, there are some constraints to calculating profit. By calculating profit, you only learn information about how much money a business has over a certain period. It doesn't address other financial considerations like the investment you need to make a profit, how much you need to sell to be profitable or how long you have to earn profits to pay off debts. You can account for the limited focus of profit by combining it with other calculations, such as profitability, to develop a comprehensive understanding of a company's financial situation.
Benefits of calculating profitability
Understanding a business's profitability can have the following benefits:
Increasing financial success
Understanding a business's profitability and value can help you make decisions that increase financial stability and growth. When you understand the relationship between a company's expenses, profits and liabilities, you can analyze multiple factors that influence the business's ability to generate profit and increase profit amounts consistently. By reviewing profitability metrics, you may develop a strategy to:
Reduce expenses to increase profits
Determine which products have the highest potential to make money
Eliminate initiatives with the lowest profitability
Displaying value to investors
Being able to show profitability information to investors can help them envision the likelihood of earning a return on their investment. Investors typically want to know not only that a company can earn a profit, but how quickly it generates positive revenue and how much profit it accrues compared to expenses. Calculating your company's profitability, especially your return on investment ratio, can help you show potential investors why investing in your company is a positive decision.
Setting long-term goals
Because profitability calculations often focus on longer periods, knowing your profitability can help you identify what long-term business goals you can realistically achieve. As you track your profitability and how different business decisions impact profitability ratios, you can make adjustments to help you better reach those goals. Understanding a company's profitability can also help you make plans for how to invest funds as profits rise or fall depending on business initiatives.
Drawbacks to profitability
Although profitability can provide a useful perspective to analyze a business's financial success, it may have some potential limitations:
Multiple calculation methods
There are several ways of calculating profitability, each with its own function and goal. You must understand the meaning of each method to select the appropriate one for your specific business goals. To maximize the usefulness of calculating profitability, identify your reason for making the calculation to determine which method is more relevant.
Room for error
Because calculating profitability requires more calculations and variables than estimating profit, there are more opportunities for errors. It's helpful to confirm the accuracy of your data before completing your calculations to reduce the chance of miscalculation. Review balance sheets and financial reports to ensure you have information from the same reporting periods before conducting calculations.
Environmental factors, economic influences and other external variables may impact a company's profitability at certain points in time. It's challenging to estimate how external factors could impact a business's future profitability, or if current profitability numbers may change based on buyer demand, trends or economic limitations. To limit the impact of external variables, use profitability as a guide that helps you decide how to run your business instead of a precise prediction of business success. It's also helpful to review new calculations often to help you understand how and why things might change.
Importance of measuring profitability and profit
Measuring your profit and profitability is important for understanding how they relate to one another. Because neither calculation provides a complete understanding of your company's finances, seeing the relationship between the two can help you understand how your business decisions can affect one or both factors. By measuring both profit and profitability, you can make educated choices that improve and strengthen a company's financial success.
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