Did you know that both the terms, profit and profitability, give you insights into distinct facets of a business? To avoid confusing the two and ensuring proper track of all business practices, one needs to understand the difference between profit and profitability in clear terms.
Profit is the amount your business gains. It is a number that remains when you subtract expenses from your revenue. In other words, the money you have leftover after you pay expenses is profit.
Profit is an absolute number calculated as total revenue minus total expenses and it appears on a company’s income statement. No matter the size or scope of the business or the industry in which it operates, a company’s objective is always to make a profit.
Profitability measures the profits gained and helps you determine the business’s success or failure. It is not an absolute number, it is a relative concept. Instead, it looks at what the business’s profits mean in the form of percentages or decimals. It is the metric used to determine the scope of a company’s profit concerning the size of the business. Thus, profitability is a measurement of efficiency. There are different profitability ratios one can use.
Furthermore, profitability can also be defined as a measure of a business’s ability to produce a return on an investment based on its resources in comparison with an alternate investment.
A business may be profit-making, but not necessarily profitable!
While accessing the financial stability of one’s company, profits alone can be deceiving. One can easily achieve a sky-rocketing profit by simply increasing revenues or cutting costs. But, having an impressive profit doesn’t necessarily mean your business is profitable. You could have positive profits that appear high, but they don’t give you the full picture of your company’s health. To find whether your company’s finances reflect success or failure, you need to look at profitability.
For example, Company X spends $100,000 to sell products costing $150,000 thus, generating $50,000 revenue. Company Y spends $900,000 to generate $950,000 in revenue. The two companies generate the same profit i.e. $50,000, but are they equally profitable?
The answer is no! The more a company spends to generate a designated profit, the more vulnerable it is to minor cost shifts, which could quickly put it out of business. Now, if Company X spends $80,000 in logistics costs, and those costs increase by 10 percent. That increases in logistics costs by $8,000, reducing profits to $42,000. Company Y spends $50,000 under logistics costs. The 10 percent increase cuts into the bottom line by just $5,000, and profits drop to $45,000. Company Y is now making $3,000 more in profit than Company X.
Because profitability is more accurate in reflecting a business’s long-term position and also its vulnerability to sudden increases in fixed costs (such as insurance, office expenses, and taxes), it is important to track profit margin and implement strategies, which keep it as high as possible.
Continuing the example above, Company X has $50,000 in net revenue and generates $150,000 in total sales, so its profit margin is 50,000/150,000 or 33.33 percent. Company Y also generates $50,000 in net revenue, but its total sales are $950,000, making the profit margin 52.63 percent. The two companies have the same amount of profit, but Company B is more profitable than Company A.
Although they sound similar, profit and profitability are exclusive when it comes to investing and business management. If you want to know how much leftover money you have, calculate your profits and if you want to know how well your business is doing at handling its revenue and expenses, find your profitability. Only measuring profits will overlook its sustainability in the long run.