Although these two terms are often used interchangeably, profit and profitability are not the same. Both can be used as indicators of the financial statements to evaluate financial success of the company, but there are some differences between the two. To adequately determine whether the company is financially stable or stimulus for growth, investors must first understand what differentiates the company’s profit from its profit margins.
The determination of profit
Profit is an absolute number is determined by the amount of income or higher net sales and the costs the company incurs. It is calculated as the sum of revenue minus all expenses and appears on the statement of profit and loss of the company. Regardless of the size and scope of the business or the industry in which it operates, the objective of the company is always profitable.
The definition of profitability
Profitability is closely linked with profit, but with one key difference. While profit is the absolute volume, profitability is relative. It is a measure used to determine the amount of profits of the Company depending on the size of the business. Profitability is a measure of efficiency and, ultimately, its success or failure. Profitability can be defined as the ability of an enterprise to make investment based on their resources compared to alternative investments. Although the company can make a profit, this does not necessarily mean that the company is profitable.
Applications In Real Life
To determine the amount of investment in the company, investors can not only rely on the profit calculation. Instead, analysis of the profitability of the enterprise it is necessary to understand if the company effectively uses its resources and its capital.
If the company is a profit, but it is not profitable, there are a number of tools that can be used to improve the profitability and growth of the company. The company quickly bogged down in disastrous projects that directly lead to sunk costs. To reduce the occurrence of failures of the project, the company can examine the profitability index to determine whether a project is worth it. This indicator allows management to take a new look at the balance of costs and benefits of the project, and is calculated by dividing the present value of future cash flows to the initial investment in the project.
The company can also increase profitability through the theory of marginal returns. One of the first steps the company is taking to improve profitability is to increase sales of the product, which requires an increase in production. Marginal profitability, also known as marginal product, it is a theory that argues that in addition to the employees up to a certain point increases the use of capital in an efficient way; if you exceed this number of workers leads to diminishing returns and ultimately less profitability. In order to be profitable, it is necessary for the company to apply this theory to their specific activities and production needs for the growth of efficient, cost effective manner.