While profit and profitability appear interchangeable, they’re actually quite different. Of course, they’re related, but referring to one over the other can have dire implications for any business. Understanding the difference between profit and profitability is critical for communicating with shareholders, management, even staff and vendors.
So, before the next company meeting, brush up on these terms to avoid any embarrassing or costly mistakes.
The Difference Between Profit and Profitability
A rectangle is always a square, but a square isn’t always a rectangle. That’s how one should view the difference between profit and profitability.
A business can make profit with awful profitability, when compared to its industry, as long as that profitability is positive. Without positive profitability, a business cannot make profit.
How are they different?
What Is Profit?
Profit is calculated by deducting a business’s total expenses from its total revenue. It is the amount left over. When that leftover amount is positive, it’s considered profit. When that amount is negative, however, it’s considered a loss.
The important detail is that profit is an absolute number. It is a numerical measurement of a business’s success. When that number is positive, it means that the business is generating enough revenue to cover all of its expenses. Increasing profit, period over period, is often the goal for most businesses because it allows them to grow and scale.
When total expenses exceed revenue, a business operates at a loss. Yet, this isn’t necessarily a sign of failure. It is common for businesses to operate at a loss for their first several years due to high startup costs. The technology industry, for instance, often sees companies incur incredible losses for many years to hopefully one day start raking in a profit. Further, a business may even decide to invest in an expensive piece of equipment, which will ultimately increase its efficiency in the long, but the books might display a loss for quite a while.
The real concern is when a business operates at a loss for an unjustifiable reason or for an unprecedented period of time.
What Is Profitability?
Profitability is similar to profit in that it depicts a business’s overall success. However, it is not an absolute number. It is a measurement of how efficiently a business generates its profit.
Therefore, profitability is calculated by dividing a business’s net profit by its total revenue and multiplying the result by 100. The difference between profit and profitability is that profitability is a relative number, a percentage, often referred to as profit margin.
Contrary to profit, there isn’t a different term for subzero profitability. When a business’s total expenses exceed its revenue, it is simply referred to as negative profitability or having a negative profit margin.
As briefly mentioned above, a business may generate profit with poor profitability, poor efficiency, just as long as profitability is positive. If profitability is negative, a business operates at a loss.
Although there are always exceptions, profitability is generally a more accurate depiction of a business’s success. There isn’t much triumph in generating a large number, profit, if a business’s ability to generate that number, its profitability, is inefficient.
For performance-based business consulting, contact The Business Turnaround Group.