Gross Profit vs. Operating Profit: What’s the Difference?

A company's gross profit is the amount of income left over after subtracting the cost of producing and selling its products from its total sales revenue. While total revenue indicates how much money a company receives in exchange for selling its goods, gross profit reflects how much money it actually earns from those sales since it factors in the cost of goods sold (COGS).

Gross profit is a valuable metric because it shows whether a company's production process needs to be more or less cost-effective compared to its revenue. For example, if gross profit decreases due to a spike in shipping costs, you could try to switch to a cheaper shipping service or reduce the weight of your product packaging.

Operating profit—also called operating income—refers to the total income a company earns from its core business activities before taxes and interest are deducted. The operating profit metric represents income that remains after direct and indirect costs from sales revenue is deducted. Business owners and investors find operating profit useful for determining a company's financial performance since the metric excludes items that are out of the management team's control.

While the terms “operating profit” and “EBIT” (earnings before interest and taxes) are often used interchangeably, a company's EBIT technically includes non-operating income—any income from activities not related to its core business operations, such as income generated by selling assets or through investments in other companies. If a business does not have non-operating income, its operating profit and EBIT will be the same.

Gross profit measures profitability by subtracting cost of goods sold (COGS) from revenue. Operating profit measures profitability by subtracting operating expenses, depreciation, and amortization from gross profit. Gross profit does not take into account all of a company's expenses and income sources, but it does show how efficiently a company operates based on the direct costs involved in producing its products. Operating profit factors in indirect costs such as depreciation, amortization, utilities, rent, insurance, marketing, office supplies, and corporate salaries.

Despite the differences between these metrics, you can use the gross profit to calculate your operating profit as shown in one version of the operating profit formula:

Operating Profit = Gross Profit - Operating Expenses - Depreciation - Amortization

To calculate the gross profit figure, subtract the cost of goods sold (COGS) from total sales revenue, as seen in this equation:

Gross profit = Revenue - COGS

In the equation, revenue represents the total amount of money earned from product sales and COGS represents the variable direct costs of producing products— costs such as raw materials, equipment, employee labor, and shipping. When calculating gross profit, some companies may substitute net sales in place of total revenue. Net sales is similar to total revenue, except it deducts the price of refunded or returned sales, allowances, and discounts.

To calculate the operating profit figure, subtract all direct costs and indirect costs from total revenue, as seen in the following equation:

Operating Profit = Revenues - Direct Costs - Indirect Costs

Another way to express this:

Operating Profit = Revenues - Operating Costs

There are different metrics you can use to track your company's financial health and compose your company's financial statements:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net income: Calculate net income (aka net profit) by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company.
3. 3. Operating profit: To calculate operating profit or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.
4. 4. Gross profit margin: A gross profit margin is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
5. 5. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.

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