Profit vs profitability: What exactly is the difference?

If you’re new to investing, you may have heard the terms "profit" and "profitability" used interchangeably. But they’re not the same thing. 

Although profit and profitability sound similar, they refer to two key performance indicators (KPIs) that measure a company’s financial success. Understanding the difference between the two can help you develop smart investment strategies. Here’s what you need to know about profit vs profitability, plus tips on using these metrics to make informed decisions. 

What is profit?

Profit is a concrete measure of a company’s total income. In basic terms, it tells you how much a company earns. A company’s profit can tell you something about its current financial health. Companies with high profits typically appear to be in good financial shape, though it’s possible for them to have high debt or management issues not reflected by their earnings alone. In other words, this metric doesn’t give you the full picture.

To calculate a company’s profit, use this formula: profit = total revenue – total expenses. You can use this formula to determine profit when evaluating investments or analyzing your business expenses. 

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Types of profit

There are two main types of profit metrics: gross profit and net profit.

Gross profit is a company’s income minus the cost of goods sold (COGS). For example, consider a restaurant that earns $100,000 in a financial quarter after spending $75,000 on ingredients, rent, and labor. The gross profit formula is: Gross profit = $100,000 - $75,000. So, the restaurant’s gross profit is $25,000.

You can then calculate the company’s gross profit margin by dividing the result by the original net sales and multiplying by 100. In this example, the restaurant has a gross profit margin of 25%.

Net profit, on the other hand, is the measure of a company’s income minus all expenses. That includes operating and non-operating expenses such as taxes, administrative fees, and marketing costs.

Let’s go back to the example above. If the restaurant spends an additional $10,000 in non-operating expenses, its net profit formula is: Net profit = $100,00 – $85,000. To calculate the net profit ratio or net profit margin, divide that result by the net sales and multiply by 100, so the restaurant’s net profit ratio is 15%.

What is profitability?

Profitability is a more in-depth look at a company’s revenue and expenses over time. This metric can provide a more accurate picture of a company’s financial health than profit alone. While profit is an isolated, concrete number, profitability takes into account other factors that can affect financial growth, including the business size and competitive market. 

There is no single formula to calculate profitability. Instead, to understand a company’s profitable margin, you should look into a few key ratios.

Profitability ratios you should know

A profitability ratio is a KPI that tells you about a potential investment’s profitability over time. Like TTM (trailing twelve months) and other business metrics, profitability ratios can help you make informed decisions to get the best possible return on investment.

Here are some key profitability ratios you should know:

• Net profit margin and gross profit margin: These help paint a clearer picture of a company’s profit.

• Return on assets (ROA): This is a measure of net income divided by a company’s total assets. ROA shows how effectively the company uses its available assets to boost revenue.

• Return on equity (ROE): This is a measure of net income divided by shareholder equity. ROE can show an investor how well the company generates cash without relying on shareholder investments.

• Cash flow margin: This metric shows how well a company converts revenue into usable cash. A high cash flow margin indicates the company can pay debts and invest in growth. It can also be a good sign of positive dividend growth.

• Operating margin: This is the amount of revenue left after accounting for COGS. In other words, it shows how efficiently a company manages its operating costs.

These are just a few ratios you can use to evaluate profitability. The more ratios you look into, the surer you’ll be that you’re investing in a profitable business.

Profitability vs profit: Differences and how they work together

Profit and profitability are important tools to help you make smart financial decisions. Like other financial metrics, they can tell you about a company’s financial health and growth potential to help you evaluate it as a potential investment. However, no metric paints a complete picture of a company’s success. Look at profit and profitability together with other KPIs to stay as informed as possible. 

The key difference between profit and profitability is the time frame. Profit shows how much a company is currently earning, while profitability tells you about its potential long-term growth. That doesn’t make profitability the more important metric, though. A company with no current profit but high growth potential isn’t necessarily a smart investment. Ideally, you want to see positive profit margins and good profitability ratios in a potential investment, which may indicate that a company is financially strong and may continue growing.

How can you find these metrics? You might be able to view the company’s public KPIs on its website, research these metrics through your brokerage, or chat with a financial advisor to get the information you need. 

Embark on profitable investment ventures along with your kids

It’s never too early to talk to your kids about smart investments. Even if they aren’t ready to start calculating profitability ratios, they can learn about the importance of unearned income and how investing works. 

Greenlight's investing app for kids* is the perfect introduction to the investing world. Starting with just $1 at a time, kids can explore different stock options, research KPIs, and propose smart investments. You'll have control over which investments are finalized so you can guide them through the process.

Investing doesn’t have to be a complicated topic. By involving your kids in your financial decision-making today, you’ll set them up for smart wealth management in the future.

* ©2024 Greenlight Investment Advisors, LLC, an SEC Registered Investment Advisor provides investment advisory services to its clients. Investing involves risk and may include the loss of principal.