Monday, August 1, 2016

Understanding Gross Profit, Operating Profit and Net Profit

The terms profit and income are often used interchangeably in the day-to-day life of new home builders.

Profit is generally understood to refer to the cash that is left over after accounting for expenses. Though both gross profit and operating profit fit this definition in the simplest sense, the kinds of income and expenses that are accounted for differ in important ways.

Let’s look at the three types of profit for your business.

The top line of the income statement reflects a builder's gross revenue from the sale of each home. From there, various expenses and alternate income streams are added and subtracted to arrive at different levels of profit.

Gross profit is the total revenue less only those expenses directly related to building the customer’s home, called the cost of goods sold (COGS). These include expenses  the entire cost of the home for your factory, raw materials, the labor to set and finish the home but exclude other wages and overhead expenses, such as rent.

The result is a profit metric that reflects the amount of money left over to fund the business after accounting for the cost of simply producing a product. While gross profit is technically a net measurement of profit, it is referred to as gross because it does not take debts, taxes, interest or operating expenses into account.

Next on the income statement is operating profit. Derived from gross profit, operating profit reflects the residual income that remains after accounting for all the costs of doing business.

In addition to COGS, this includes fixed-cost expenses such as rent and insurance, variable-cost expenses such as shipping and freight, payroll and utilities, as well as amortization and depreciation of assets. All the expenses that are necessary to keep the business running must be included.

However, like gross profit, operating profit does not account for the cost of interest payments on debts, additional income from investments or taxes. Gross profit reflects the profitability of a company's operations.

Net profit, is the infamous bottom line. This reflects the total residual income that remains after accounting for all cash flows, both positive and negative. From the operating profit figure is subtracted all debt expenses such as loan interest, taxes and one-time entries for unusual expenses such as lawsuits or equipment purchases.

One item in particular can cause your net profit to plummet and you won’t even know it for a year. Service calls and repairs during the first 12 months can destroy your ‘Bottom Line’.

All additional income from secondary operations or investments and one-time payments for things such as the sale of assets are added. The result is arguably the most important financial metric of them all, reflecting builder's ability to generate profit for  the owner.

1 comment:

Anonymous said...

Has anyone figured the costs for a modular home similar to these figures?