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Gross and operating profit

Difference between gross profit, operating profit, and net income. Created by Sal Khan.

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  • spunky sam blue style avatar for user Teka teki
    At 1.45, how about company that operate based on services? like solicitors or barber. These business not incurred any cost of good sold. How do they calculate gross and operating profit?
    (14 votes)
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  • leaf green style avatar for user TL
    What is D&A? Can someone explain more? I understand depreciation but not the other one.
    What is EPS?
    (5 votes)
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    • blobby green style avatar for user ashishsinglaca
      Tangible assets are depreciated and intangible assets are amortized (Accounting convention, I guess).
      The difference in name could be that intangible assets may or may not depreciate in value. for e.g. patent, but its cost of use needs to be allocated for working out the correct profit/ loss for a year in the financial statements.

      EPS - Earnings per share - Earnings(Profit) after Interest Depreciation & Amortization divided by outstanding number of shares. It is used to compare earnings per stakeholder delivered by a company.
      (8 votes)
  • blobby green style avatar for user mineva.glasgow
    What is the meaning of fair value?
    (2 votes)
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    • piceratops ultimate style avatar for user Darmon
      To better answer your question, I will use an example. Say you have a chair and you want to figure out its value for business or sale purposes. You can use two methods: fair value and historical value. Historical value means you value the chair at the same price as you originally bought it. Fair value would be pricing the chair based on the current market for it, which is usually done by an assessor if the item is valuable. So the fair value of something is basically its current value on the market. Hope this helps! :)
      (13 votes)
  • blobby green style avatar for user Karam  Abdulla
    so is it the net income of the company that is being distributed amongst the investors or the operating profit?
    (1 vote)
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  • leafers sapling style avatar for user Josiah R
    Why does Depreciation show up on the balance sheet as a cash item/operating expense? Is that money meant to be set aside in a contingency fund for replacing equipment or the items being depreciated?

    What does Amortization mean in this scenario since Ben's shoes does not have any debt? What is being amortized?
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      Depreciation is not on the balance sheet, perhaps you are thinking of the income statement.
      It reflects the fact that even though you don't have to buy a new car every year, your car eventually wears out, and you need to buy a new one. It would not be a good picture of your profit to say that it goes down a lot in the years you buy a car but it is high in years when you don't buy a car, So we spread the cost of the car over the amount of time we expect to "use it up"

      Sal has videos about depreciation.
      (2 votes)
  • male robot hal style avatar for user Retr0
    At Sal says that interest expense isn't included in expenses coz it is dependent on operating profit. Why? What does it mean?
    (1 vote)
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  • male robot hal style avatar for user Enn
    In this video Sal mentions that Gross Profit is the revenue with the cost of goods sold deducted and Operating Profit is the Gross Profit with cost of running the business deducted further. Further Net Income is the Operating Profit after the deduction of Interest Expenses and Taxes.
    Where will the Net Profit come in this or is Net Income the same as Net Profit ?
    (1 vote)
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  • male robot johnny style avatar for user Alon Granot
    Can a company have loans and not specify their payment in the income statement?
    (1 vote)
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  • piceratops ultimate style avatar for user Haider Gilani
    This isn't what i'm trying to find, can somebody help me solve this, "Jacob sold a computer in $55,000. He suffered a 25% loss in it. Find the purchase price of the computer."
    (1 vote)
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  • leafers seed style avatar for user Edgar De La Cruz
    Im having a difficult time trying to understand what exactly revenue is and where it comes from. Can someone "dumb it down" for me?
    (0 votes)
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    • ohnoes default style avatar for user Tejas
      Revenue is basically how much you initially get from selling your product. To calculate revenue, you simply multiply the price which you are selling at by the quantity sold. This is the money you end up with after selling your product, but before paying your expenses.
      (3 votes)

Video transcript

Voiceover: What I want to do in this video is to see if we can understand all of the different parts of kind of a traditional income statement. As we get into more and more complicated examples, you'll see more and more complicated income statements, but this is a good start. What I've done here is I've drawn the income statements for actually two businesses. One is Ben's Shoes, and one is Jason's Shoes. I did that because these are fundamentally the same business, but they have a slightly different capital structure, and we'll talk about what that means in a second, but they're both shoe stores. They literally, they buy shoes from shoe manufacturers. They put them on their shelves, and then customers come in and buy those shoes. The first line, we're pretty familiar with it already. This is the revenue, this is the sales for each of these shoe stores. In the case of a shoe store, it's literally just going to be a measure of the cash that the customers are paying for the shoes. You wouldn't have something like accounts receivables, where people can pay months later. Most of it will just be cash. Cost of goods sold, in this example, we're just going to assume it to be the actual cost of a shoe. If I sold a pair of $100 shoes, but I had to pay $50 to the shoe manufacturer for those shoes, that $50 would be the cost of goods sold. So this $100,000 is actually the cost of the $200,000 in sales. Then when you just take the cost of goods sold from that revenue, you get something called gross profit, and really, the focus of this is is, of this video is to try to understand the difference between gross profit, operating profit, pre-tax income, net income. Gross profit is the first time that you kind of think of profit, and the reason why it's called "gross" is because we've just thought about the profit from selling that incremental shoe, and sometimes some other costs are thrown in there. Sometimes advertising, sometimes some other cost associated with the store, but for this example, it's just the profit straight from selling that incremental shoe, and that's why we call it gross, since we haven't taken out other things yet. Then, below that line, we have all of the other expenses, the expenses associated with running the store. The kind of the overhead of running that store, So we have the rent, you have the salaries, you have the depreciation and amortization. Maybe you're depreciating the cost of your cash register and the shelves, and whatever else, and then you can have other things like utilities, and you can see both Ben's Shoes and Jason's Shoes are completely identical up to this point. They have the same revenue, gross profit, even the same expenses. And so when you take all of these expenses out from the gross profits, you take 100,000 minus all of these, and I've written all of the stuff you subtract with parentheses around them, so that these are expenses, these are negatives. You get the operating profit, and you see that both of these are the same number. What operating profit tells you is how much profit is coming from the business. It's before we think about how the business is structured. It doesn't think about things like interest income from your bank account, or interest expense on any loans you have. It's from the business itself, operating profit, and since these are identical businesses, they have the same exact operating profit. Where they start to diverge is below that line. Above this line right over here is the income statement, down here is the balance sheet. Their balance sheets are identical, except for Jason's Shoes has $100,000 in debt, and Ben's Shoes has no debt. Ben has no interest expense, while Jason does have a $10,000 interest expense, so it's about 10% per year. That's why these two income statements start to diverge, but notice, we didn't put this expense up there because it has nothing to do with the operations. It's dependent on how the operations were financed. Once you subtract that out, then you actually have your pre-tax income, and if we assume that we have to pay taxes, this is how much we pay in taxes, and this is actually the net income that goes to the owners of the company.