A ladder from revenue to net profit
Think of the income statement as a ladder you walk down one step at a time. Each step subtracts one kind of cost, and the figure left at each step has a name. Here is an invented company, in EGP millions:
What each level measures
Gross profitRevenue minus cost of sales. Shows how much the product itself earns before the cost of running the company. Driven by selling prices and material costs.
Operating profitGross profit minus selling and admin costs. Shows what the core business earns before looking at how it is financed.
Net profitAfter interest, tax and any other gains or losses. What is actually left for shareholders.
Operating profit matters because it strips out the effect of debt. Two companies doing the same work equally well, one with large loans, will show similar operating profit and different net profit.
Same net profit, different story
ExampleTwo invented companies each report net profit of 93 million. The first has operating profit of 150 million from selling its products. The second has operating profit of only 40 million and reached 93 because it sold land at an 80 million gain. The bottom line is the same, but the first earns from recurring business and the second mostly from an event that will not repeat.
Watch outLine names vary between companies, and some place items differently. If you are not sure what sits inside operating profit, check the notes instead of assuming.
Dividing each level by revenue gives the profit margins, the subject of the profit margins lesson.
Find the three levels
Open any company's income statement from the disclosure archive and find gross, operating and net profit.
Check yourself
1. Gross profit 300, selling and admin costs 120. What is operating profit?
300 − 120 = 180.
2. Which profit level is not affected by loan interest?
Interest is subtracted after operating profit.
Summary
- Gross profit = revenue − cost of sales.
- Operating profit = gross profit − selling and admin, before interest and tax.
- The same net profit can hide different sources, so look at every step.