Operating Profit vs Net Profit: Key Differences
Sourav Banik
Author
A business thrives on the profit it makes, and this profit entirely depends on its growth and ability to manage market demand. Without any profit, a business simply fails to revive and lose the motivation to continue sailing further in a vast ocean of commerce. While a business can at its best, float in the absence of profit through debt financing or crowdfunding, it can be hardly acknowledged as a long-term strategy. Almost every business tries to cross the mark where it is not only making a consistent revenue but also earning profit. Profit is the incentive for which investors and business owners take collective risks and invest their wealth. In this blog, we are going to learn in detail about operating profit vs net profit. While these two terms may seem similar, in commercial glossary, they carry large differences.
What is Operating Profit?
Concepts such as operating profit are crucial to understanding operating profit vs net profit notion.
Operating profit refers to that portion of profit where the firm’s expenses are deducted from the gross profit, such as earnings before interest and taxes (EBIT). Expenses such as depreciation cost, office space rent, and employee salary, when deducted from the main income, the firm arrives at operating profit. In simpler words, operating profit is the leftover profit that remains after the daily expenses of a firm are deducted from the gross profit.
Calculation of Operating Profit
Calculation of operating profit is easier with an example. Let’s first review the formula:
Formula
Operating Profit = Revenue - Cost of Goods Sold (COGS) - Operating Expenses Here, Revenue is the net income from sales of goods and services COGS is all direct expenses for manufacturing the goods Operating Expenses include expenses for daily business management
Example of Operating Profit
Let’s assume a hypothetical case scenario. A firm, AVN Internationals had recorded a revenue of ₹5,00,000, while its other expenses are:
| Particulars | Expenses |
|---|---|
| Cost of raw materials | ₹30,000 |
| Overhead expenses | ₹5,000 |
| Factory rent | ₹3,000 |
| Cost of packaging | ₹4,000 |
| Electricity expenses | ₹20,000 |
| Labour wages | ₹1,50,000 |
| Sales cost | ₹1,00,000 |
| Marketing cost | ₹40,000 |
| Administrative expense | ₹60,000 |
Cost of Goods Sold (COGS) = Cost of raw materials + Overhead expenses + Factory rent + Cost of packaging + Electricity expenses + Labour wages = 30,000 + 5,000 + 3,000 + 4,000 + 20,000 + 1,50,000 = ₹2,12,000
Operating Expenses = Sales cost + Marketing cost + Administrative expense = 1,00,000 + 40,000 + 60,000 = ₹2,00,000
Operating Profit of AVN International = Revenue - COGS - Operating Expenses = 5,00,000 - 2,12,000 - 2,00,000 = ₹88,000
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Importance of Operating Profit
- Operating profit determines and signals the efficiency of the business. Any change in the operating profit indicates the way a small business or a startup is handling its core business.
- Firms get a fair idea about managing their expenses by knowing the operating profit. An operating profit measures the cost of goods sold and expenses such as administrative costs, which practically helps the firm to ideate its sales funnel and minimization of cost.
- Operating profit helps investors take a step towards investing in a company as they can easily understand the ability of the company to meet its day-to-day expenses.
- Firms can budget and set aside contingent funds by taking a look at its operating profit. By looking at the operating profit, firms can easily trim down the rising expenses.
What is Net Profit?
A net profit is the residual profit remaining after tax, interest, refunds and dividends are deducted. A net profit is the actual profit that the business earns in a given period, and serves as a benchmark for a business. In a financial year, a business usually compares the net profit it has earned in its previous years with the net profit it has earned in the current financial period.
When discussing the difference between operating profit and net profit, it is important to keep in mind that the consequential impact of net profit is more than operating profit. If a firm has to reflect and look back at its balance sheet, it must first understand how much profit it is actually earning. Net profit gives a true snapshot of the profit a firm is left with after paying off all its debts and expenses.
Also read the main difference between gross profit and net profit.
Calculation of Net Profit
Here is a quick reference to how net profit is calculated.
Formula
Net Profit = Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Interest Expense - Taxes
Example of Net Profit
As we explained the concept of operating profit with an example, here is another example to illustrate net profit better. Bernkey & Cakes made a total ₹8,00,000 in revenue for the financial year ended 31st March 2024. Here is a list of all the expenses incurred by the firm during this time:
| Particulars | Expenses |
|---|---|
| Cost of Goods Sold | ₹50,000 |
| Factory rent | ₹60,000 |
| Depreciation | ₹10,000 |
| Utility Expenses | ₹5,000 |
| GST | ₹1,00,000 |
| Income Tax | ₹1,25,000 |
| Sales cost | ₹2,00,000 |
| Corporate Tax | ₹70,000 |
| Marketing cost | ₹1,20,000 |
| Administrative expense | ₹40,000 |
Operating Expenses = Sales cost + Marketing cost + Administrative expense + Depreciation + Utility expenses = 2,00,000 + 1,20,000 + 40,000 + 10,000 + 5,000 = ₹3,75,000
Taxes = GST + Income Tax + Corporate Tax = 1,00,000 + 1,25,000 + 70,000 = ₹2,95,000
Operating Profit of Bernkey & Cakes = Revenue - Cost of Goods Sold (COGS) - Operating Expenses - Taxes = 8,00,000 - 50,000 - 3,75,000 - 2,95,000 = ₹80,000
Key Differences Between Operating Profit and Net Profit
Net profit and operating profit have parallels, but are still two different concepts. Here is operating profit vs net profit explained in a neat way.
| Basis of difference | Operating Profit | Net Profit |
|---|---|---|
| Definition | Operating profit refers to profit that a firm receives after deducting depreciation and operational expenses | Net profit refers to the remaining profit after deducting indirect tax and operating expenses from operating profit |
| Importance | Operating profit is required for understanding the overall efficiency of business | Net profit is required for understanding the company’s profitability and liquidity |
| Accounting treatment | Recorded in Income Statement | Recorded in Profit and Loss Statement |
| Objective | Understand how an organisation manages its daily operations and expenses | Understand the amount of actual profit a firm is making |
| Risk and Reward | Operating Profit is used for improving the cash flows and the enhanced investing capability of the business | Net Profit is used to portray a transparent financial picture to the firm for taking strategic decisions and understand market debt |
Conclusion
This blog about operating profit vs net profit mainly discusses the critical points with examples. While operating profit gives SMEs and startups a memo of how the daily expenses are being managed, net profit informs a firm of its actual profit after payment of all taxes. If you are considering scanning the financial health of your firm, you may have to examine both of these concepts. Operating profit is required for taking daily business decisions, and net profit helps in the form of taking long-term decisions. These key indicators are the barometers of a business, as they help a business move forward with informed decisions.
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Frequently Asked Questions
Explore moreAre net profit and operating profit similar concepts?
These two concepts are completely different although they have few similarities. Operating profit stands for the profit a business is earning in its daily operations, while net profit refers to the residual profit a business has left after paying off taxes and expenses.
How can I enhance my operating profit?
Enhancing your operating profit calls for a focus on revenue increase and expense management. Your business can make decisions such as changing pricing strategy, streamlining production processes or even negotiating with new suppliers.
What does a negative net profit signify?
A negative net profit indicates that the company spent more than it made in revenue. This is a red flag and something that needs to be addressed as soon as possible and could mean there are financial deficiencies within the company.
How often should I check my operating and net profit?
You should check your net and operating profit levels at least monthly or quarterly, ideally. This enables you to identify early trends and issues and act early to correct them.
Can insurance assist in safeguarding my profits?
Yes, company insurance such as Directors & Officers Liability Insurance can safeguard your profits by averting risks and monetary losses as a result of unforeseen circumstances and legal liabilities. This will minimize major risks such as legal liability or mismanagement lawsuits against your company directors.
What is the difference between profit and net profit?
The only difference between net profit and profit is that profit can be found by deducting the expenses from revenue, while net revenue is found by deducting the expenses from the gross profit or profit in simpler terms.
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