The 3 Types of Profit - What They Are and How to Improve Them

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The long term success of your business relies on the ability to generate a profit. Despite it's importance, profit isn't understood by many small business owners. Below we explain the three types of profit and how you can improve them. 


Gross Profit

Gross Profit is the revenue left to fund your business after paying for the cost of creating your product or service. 
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How to Improve Your Gross Profit: 

  • Cut Low Margin Products and Services - You can use a similar calculation to determine the gross profit of a single product or service. This could help you make decisions about which products or services to drop or keep. Here's the calculation:  Revenue of Product A  – Cost of Goods Sold of Product A = Gross Profit of Product A.
  • Reduce Cost of Goods Sold - This may mean negotiating with your suppliers for better deals. Consider asking your distributors for discounts for bulk-purchases or a discount for being a loyal customer. 
  • Watch Out For Wastage - Learn how to forecast your inventory levels so you don't waste money on unused or spoiled inventory. 
  • Increase Prices  - Before making this decision you should assess your customer's price sensitivities. Consider what you could do to add value to existing products or services to justify the price increase. 
  • Limit Discounting - Many business owners discount their products or services to sell more. Ask yourself if the promotion is bringing in more orders than you'd get on average. If not, then your promotions might be harming your profits. 
  • Increase the Average Purchase Amount - Consider cross-selling and up-selling customers by offering extra products/services or larger units for them to buy.

Operating Profit

Operating Profit is the revenue left after accounting for the cost of producing your product or service and the cost of running your business. Operating expenses includes things like rent, marketing, payroll, insurance, equipment, depreciation and administrative tools.
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How to Improve Your Operating Profit: 

  • Improve Processes - You can reduce your operating expenses by improving the time it takes to complete an order. Look at the steps needed to fulfill an order and ask yourself: "How can I speed up the process? Are they any steps I can cut?" The faster you can deliver your product or service, the higher your operating profit.
  • Embrace Technology - Automating or digitizing your processes can help you save time and money. For example, Buffer can help you automate your social media posts. Also, Quickbooks is an online accounting platform that can manage business payments, payroll, and pay bills.

Net Profit

Net profit is the revenue left once you take away all costs, taxes and interest.

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How to Improve Your Net Profit:

  • Use Tax Deductions - Your small business can deduct all expenses necessary for doing business. This includes wages, vehicle expenses, supplies, interest, rent or mortgage payments and employee benefits. Make sure you can support your expense claims with your receipts, invoices, and deposit records.
  • Claim Your Tax Credits - While deductions reduce your taxable income, credits come off your tax bill. The CRA offers a wide variety of tax credits you may be eligible for. 
  • Depreciate Your Assets -  You can depreciate any asset that lasts more than one year. Assets go down in value over time, and you can count that decline in value as an expense for your business. 
  • Offer Employee Benefits -  You pay payroll taxes on your employees. If you want to keep your payroll taxes down, offer employees added benefits instead of bonuses. You don't pay taxes on benefits so you can write them off as expenses.

Moving Forward

Understanding the three types of profit will help you:

  • Improve performance - You'll be able to spot issues like excess spending or an underperforming product or service. This is helpful information to assess how your business can move forward. 
  • Secure funding -  Lenders want to know if you're profitable before giving you a small business loan. For example, Lendified requires your business to generate an operating profit before approving you for a loan! 

By using our tips, you'll be able to improve the profitability of your business. For more helpful ideas on how to increase the performance of your business check out our guide on how to grow your revenue to $1 Million

 

About the Author

Lendified

Lendified is Canada's premier online lender for small businesses. The company was founded by former bank executives dedicated to provide businesses with fast, easy, and affordable financing. The Lendified team regularly produces blogs and guides to help small business owners succeed.