Part 2: What Is Profit?

Profit is the financial reward your business earns after paying all its expenses. It’s often called the “bottom line” because it’s what’s left after everything else has been accounted for.

But there’s more than one kind of profit — and each tells a different story.

📊 Types of Profit

1. Gross Profit

Formula: Revenue – Cost of Goods Sold (COGS)
Gross profit shows how efficiently your business produces or delivers its core product or service.

Example:
You sell £50,000 of products. Your product costs £30,000 to make.
➡️ Gross Profit = £20,000

2. Operating Profit (EBIT)

Formula: Gross Profit – Operating Expenses
This reflects the profit your business earns from operations before taxes or financing costs.

Includes: Rent, utilities, wages, marketing, insurance.

3. Net Profit (or Net Income)

Formula: Operating Profit – Taxes – Interest – Other Expenses
This is the most “complete” profit figure — and the one you’ll see on your year-end accounts. It shows your business’s true profitability after everything is paid.

🔍 Profit vs Revenue: Don’t Confuse the Two

Many businesses boast about “making £1 million a year” — but that’s revenue, not profit.

A business earning £1 million and spending £950,000 has just £50,000 net profit — and that’s before taxes!

📌 Why Profit Matters

✅ Shows if your pricing and margins are sustainable
✅ Helps you evaluate performance year-on-year
✅ Is used by lenders and investors to assess your business
✅ Determines what you owe in tax
✅ Informs reinvestment and dividend decisions

🚫 Common Profit Pitfalls

• Counting income before it’s received

• Ignoring hidden or indirect costs

• Overestimating margins

• Forgetting tax obligations

• Relying solely on year-end figures

🧠 Real-World Example: “Profitable but Struggling”

A local café reports £10,000 net profit in its annual accounts — but struggles to pay rent each month.

Why?
Because customers are paying with card (delayed funds), and large seasonal costs (like heating or holiday pay) hit cash flow hard.

This is where understanding cash flow becomes critical — and we’ll cover that in the next section.