Gross profit and operating profit are basic accounting terms which appear in the profit and loss account of the company and every accounting student knows about these two terms but if one asks what are the major differences between the two then chances are many will not know the complete answer and that is the reason why one should know the difference between gross profit and operating profit –
Gross Profit VS Operating Profit
Meaning
Gross profit in simple words refers to that profit which is earned by the company after subtracting direct costs associated with making the product from the sales done by the company during the financial year while operating profit refers to that profit which is earned by the company after deduction of all operating expenses incurred by the company from the gross profit figure. In short operating profit also known as earnings before interest and taxes figure will always be less than gross profit for a financial year.
Formula
The formula for calculating gross profit is Sales – Cost of goods sold where sales is the net sales whether its cash sales or credit sales done by the company and cost of goods sold includes all direct expenses associated with the production of goods whereas the formula for calculating operating profit is gross profit – operating expenses done by the company during the year, however, interest and tax are not deducted while calculating operating profit and that is the reason why it is also called earnings before interest and taxes.
Complete Picture
Gross profit shows the amount of sales done by the company and direct expenses involved in making the sales, however, it does not reveal much about the company’s operating performance and a higher gross profit figure does not guarantee that company will have net profit during the year while as far as operating profit is concerned it presents a more clear picture about company’s operating performance during the year which in turn can help the company in controlling the operating costs. Further, a higher operating profit is an indication of the company’s superior operating performance and if the company has zero debt then ignoring the taxes operating figure will be the final profit figure as far as the company is concerned. In simple words, gross profit is like a trailer of a movie as it does not depict the true position of the company while operating profit is like a whole movie as it shows the true financial position of the company.
Appearance
Gross Profit appears in the trading account of the company when the company makes a separate trading account and profit and loss account while operating profit appears in the profit and loss account of the company.
Example
An example of gross profit is suppose the sales of the company is $100000 and opening stock is $20000, closing stock $30000, purchases are $60000 and direct costs are $10000 then the cost of goods sold will be $60000 ($20000+$60000+$10000-$30000) which results in gross profit being $40000. An example of operating profit is when the administrative expenses are $10000, selling expenses are $5000, and rent expenses are $5000 than total operating expenses comes to $20000 and operating profit will be $40000 – $20000 = $20000. Hence in a way operating profit cannot be calculated until gross profit is calculated as gross profit is the first step when it comes to calculation of profit.
As one can see from the above that there are many differences between the two and if you are one of those people who love to read and analyze profit and loss account and balance sheets than you should be aware of the differences between the two terms to have a better understanding about profitability aspect of the company.