Earnings And Profits – Understanding The Difference
Many of us will remember an old business saying:
What you earn is what you get to keep
While earnings and profit are related, they are certainly not exactly the same.
Earnings, usually indicates the income that a business earns which is more often than not is calculated by deducting the costs of purchasing raw materials, manufacturing, transporting of finished goods etc. from the revenue earned by sales of the products. Profit, on the other hand, is what the company gets to keep after taking care of all of its business-related expenses. It is entirely possible that a company may have an impressive amount of earnings but have very little profit.
It may be a good idea to look at an example to understand these concepts and the differences between them. Let’s take an online shopping company that generated about Rs. 10 lakhs from the sale of goods on its website. It may cost the company about Rs.7 lakhs to purchase and deliver the goods to its customers. Hence, the company’s earnings for the week is Rs. 3 lakhs. However, if the company incurs other costs like staff costs, administrative costs etc. of Rs. 2 lakhs, what the company earns is only Rs. 1 lakh rather the Rs. 3 lakh what was left over after the cost of delivering the products to the customers.
Not understanding the difference between earnings and profit may have a devastating effect on a business. Very often, new business owners begin to see large volumes and become prematurely excited by measuring the success of their businesses on the number of sales they make. How much they actually make out of these sales is sometimes ignored. This is especially true in the case of businesses like restaurants where revenues happen over the counter but costs like rentals, administrative expenses, procurement costs need to be paid at a later date. If one sits down and calculates all the associated costs, it may occur that the profits are far more modest and lower than anticipated. In fact, the business may not even be breaking even. If a business begins to spend money without considering the actual profit versus earnings, it may be laying the path for financial failure.
This concept may even apply to your online stock trading activity. While you may be earning well due to your astute trading skills, taxes, brokerages etc. may eat into your earnings and lower your taxes substantially. Make sure that you understand your tax implications and rates applicable to you. A smart way to keep your brokerage costs low is to opt for smart brokerage plans that companies like RKSV offer. You can use the profit and loss calculator provided on the website to actually know how much profit you make on your trades. This will help you plan strategies for trading.
Earnings and profit calculations are often used to determine the financial health of a business. They are typically used in reporting business income to tax authorities as well. Often, tax agencies want to know how much a business has collected over a period of time, the cost of the goods or services it sold, and the amount of profits it has earned.
With us now understanding the difference between earnings and profits, not only are we better equipped in understanding companies and their financials better, we are also now ready to apply these concepts to our lives and really understand if many of things we do in life are actually worthwhile.
Happy investing !!