What is profit?
There may be many reasons why people choose to invest their money, but it’s generally safe to say that people want to see their investment grow. For this reason, when deciding where to invest your money, a simple indicator is to look at the profits of a company. Essentially this shows how good a company is at making money.
Profit is the amount of money a company makes (revenue) minus the cost of running the business (expenses).
Profit can go up or down (fluctuate) during short periods, so it’s important to look at the company’s ability to generate profit over a longer time. This information can be found in a company’s annual report or income statement. Looking at a company’s profit margin can also be a good indicator of how they use their revenue.
As an investor, there are three types of profit to become familiar with since they provide different information.
1. Gross profit — This is the amount of money a company makes minus the direct cost of making and selling the products or service (material, overhead, storage). Salaries, rent, interest on debt and other financial obligations still need to be paid so gross profit gives limited information. Once the expenses are paid, you get the:
2. Profit before tax — This is useful to know because taxes vary from country to country, so you could find a company that is good at making profit with low expenses but then is hit with high tax payments. However, if you want to only look at one sum to get a quick overall glimpse into the business, you should look at the:
3. Net profit — also referred to the net earnings or net income — this is essentially the total profit the company makes after all the expenses were deducted. Based on this figure, you can tell whether the company ‘made a profit’ or ‘made a loss’ in the financial period shown on the income statement.
Profit at what cost?
Beyond all the numbers, it is important to consider how the company is making a profit. When you invest, a company uses your money to carry on its business, so it is important to be aware of how that company is using your money.
For example, Company X generates a good profit each year however it tries to minimise expenses by using extreme practices that are cheap and harm the environment. The long term effects of these practices have global consequences that affect human rights and climate change.
Company Y, on the other hand, also makes a good profit, but instead chooses to locally source material and pay a fair wage to workers. As an investor, you have a great deal of power in this case to choose to invest in Company Y — supporting sustainability over making profit at any cost.
It’s important to remember that the fact that a company has a strong sustainable focus, does not mean they will be more or less profitable than other industries. And that’s why it’s good to be familiar with some basic financial lingo and impact investing concepts when you are starting out.
Kate Harris is a copywriter at MakeImpact, a Nordic Impact Fintech that helps individuals make sustainable investment decisions through their values.
