Gross profit vs. operating profit (differences and tips)
By Indeed Editorial Team
Published 14 November 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Gross and operating profits are two financial metrics that companies use. If you work with an organisation's finance, accounting or management teams, knowing the differences between these metrics can improve your job performance. Learning the characteristics of the two and how they compare to each other is a valuable skill that you can acquire through research. In this article, we define and compare gross profit vs. operating profit and provide tips for increasing company profit.
Difference between gross profit vs. operating profit
Though these metrics are both useful for assessing a company's health, there are some key differences between gross profit vs. operating profit. They include:
When making financial decisions, investors consider both numbers but in different ways. They may check a company's gross income because it tells them how a business performs financially and if its cost of goods sold (COGS) is smaller than its profits. In other words, it demonstrates its profitability. Reviewing an organisation's operating profit shows the company's performance during a specific period, for example, in a year.
After conducting an in-depth analysis of the operating profit, stakeholders can find ways to maximise a business's operating potential. This usually involves minimising major costs, like labour and supplies, while maximising profits. Analysing gross income helps with excess cost management.
Although gross profit is one of the most useful company metrics, it's unlikely for stakeholders to make impactful business decisions using only this number. It's because it doesn't include taxes or interest on loans. Operating profit is much more reliable since it's a true profit that an organisation has and can use instantly.
What is gross profit?
Also referred to as gross income, gross profit is the money a company has after covering its direct expenses, like manufacturing and sales costs, but before any deductions, like operating expenses. The following is a formula to calculate gross profit:
Gross profit = total sales - cost of goods sold
Any company that sells products or services can benefit from calculating its gross profit. The number that represents its gross income demonstrates how efficient the company is with utilising its resources, including supplies and human labour. When calculating gross income, companies can consider the following examples of COGS:
compensation for employees who directly handle the sales
purchase price of the goods they're selling
What is operating profit?
Operating profit, also referred to as operating income, is the amount of money a company has after covering all operating expenses, including marketing costs or administrative spending. It refers to the funds that stay within the organisation to support its day-to-day operations, which is where the name comes from. Operating profit is the amount before taxes and external investments. The following is a formula that you can use to calculate operating income:
Operating profit = gross profit - operating expenses - depreciation - amortisation
How to calculate gross profit
When you know how to calculate gross profit, you can determine if a company or any of its products are profitable. Here's what you can do to calculate gross income:
1. Find the company's income statement
The first step to calculating gross income requires that you locate the company's latest income statement. An income statement is a formal financial document that serves to demonstrate an organisation's earnings and expenditures. Other metrics it features include losses or a breakdown of revenue from services, products or rentals.
2. Determine COGS
Next, find metrics that represent the cost of goods sold. This is the total cost of the commodities that the company sold to customers. It involves elements like the cost of materials, but also costs of labour or storage. If the company's statement doesn't have a metric for this, you can calculate COGS by adding up its opening stock and purchases and then subtracting closing stocks.
3. Calculate total revenue
The second metric that you use to calculate gross income is total revenue. To do that, add up all revenue that the company generated from sales. Remember that using specific numbers from an income statement allows you to calculate gross income for that same period.
4. Use the gross profit formula
Lastly, you can use the gross profit formula. To do it, subtract the company's COGS from its total revenue. To get a better understanding of a company's progress or growth, it's helpful to compare results from several statements.
How to calculate operating profit
Calculating an organisation's operating profit allows you to use relevant metrics to establish how healthy its internal decisions are. Here are some tips you can use to calculate operating income:
1. Use the number representing total revenue
To calculate operating profit, you can also use a company's income statement. Firstly, determine how much money it has generated during a specific period. To do that, add up money from its different sources of income, including selling goods and providing services.
2. Find the COGS
Next, determine the cost of goods sold. Simply add up all costs proportional to the number of goods the company sold. If you already calculated the company's gross profit, you can use the same number you used there.
3. Determine other operating expenses
Unlike in the gross profit formula, calculating operating profit also requires that you identify any other operating expenses. This includes utility bills, rent and the cost of marketing campaigns. It also takes into consideration any supplies that the company ordered to manufacture products and sell them.
4. Consider depreciation and amortisation
Depreciation is the value that a company's asset loses. Amortisation refers to the spreading of an asset's costs over its projected lifetime. Note down these two numbers, as they're essential for calculating the operating profit.
5. Use the operating profit formula
In the last step, apply the numbers you identified to the operating profit formula. At first, take the figure that represents the total formula. Then, subtract the cost of goods sold, operating expenses, amortisation and depreciation from it.
Tips for increasing company profit
Calculating gross profit and operating profit is often the first step to understanding what's happening within an organisation when you want to increase its profitability. Here are some tips you can use to do that:
Implement lead generation and conversion processes
Lead generation is a process that helps you attract new prospective consumers, which are people potentially interested in purchasing something from you or the company you represent. Lead conversion turns those people into actual customers who've spent money with you. There are various methods you can use to generate leads and convert them into buyers, for example, cold calling or email outreach.
Increase the total number of transactions
You can help a company earn more by increasing the number of its monthly transactions. In some instances, this is possible to accomplish this without increasing the number of customers it has. To do it, it's necessary that you convince the same customers to purchase more frequently, for example, by using upselling methods.
Implement a referral programme
Word of mouth (WOM) is a powerful marketing technique that helps companies acquire more buyers. It requires convincing existing customers that recommending the company's products or services to the members of their network is a good idea. Some organisations do this by investing in affiliate marketing, which allows consumers to profit from each successful recommendation they make.
Increase the size of the transaction
Another way to improve profitability involves increasing the size of a standard customer transaction. Depending on the business model and how the company sells, there are different ways to approach this. For example, changing a supplier and getting higher quality raw materials for the same price you've been paying can help you increase the price of the company's best-selling products.
Explore more articles
- 11 types of experience for young people (plus benefits)
- What is a Spring tutorial? (With applications and tips)
- 11 of the best time management apps for scheduling work
- How to write an employee evaluation (with definition)
- What is omnichannel retail? (Benefits and implementation)
- What is capacity management? (Plus best practices)
- 14 novel writing tips to help you finish your book
- Skype versus Zoom: importance and a five-point comparison
- Guide to managerial experience vs supervisory experience
- How to create a strategic plan that works for your business
- Social media marketing (With benefits, steps and jobs)
- Types of marketing campaign: definition and benefits