Calculate gross profit, operating profit, and net income from a simplified income statement.
Accounting profit is the bottom line on a company's income statement — what's left after every explicit cost is subtracted from revenue. It's the number tax authorities care about, the number shareholders are paid from, and the number that flows into retained earnings on the balance sheet. Understanding how it's built, line by line, is the foundation of every more sophisticated financial analysis.
Revenue
− COGS
= Gross Profit
− Operating Expenses
= EBITDA
− Depreciation & Amortization
= Operating Profit (EBIT)
− Interest Expense
+ Other Income
= Earnings Before Tax (EBT)
− Income Tax
= Net Income
Gross profit is the first profitability gate. It answers: "After paying for the cost of producing what we sold, how much money is left to cover everything else?" Gross margin (gross profit ÷ revenue) is the most important pricing-power signal in any business. Stable or rising gross margins mean the company is keeping pace with input-cost inflation through pricing or efficiency. Declining gross margins are the earliest sign of commodity pressure or supplier-cost shocks — they show up here before they reach the bottom line.
| Sector | Gross margin | Operating margin | Net margin |
|---|---|---|---|
| Software / SaaS | 72-88% | 22-30% | 15-25% |
| Pharmaceuticals | 65-78% | 20-30% | 15-22% |
| Consumer brands | 40-55% | 15-22% | 10-15% |
| Industrials / manufacturing | 25-35% | 8-12% | 5-9% |
| Retail | 25-40% | 4-8% | 2-5% |
| Grocery | 22-28% | 2-4% | 1-3% |
| Banks | N/A | 35-45% | 22-30% |
Accounting profit captures only explicit costs — money that leaves the business. Economic profit also captures implicit costs, primarily opportunity cost: what could the owner be earning at a salaried job? What return could the invested capital earn elsewhere? A solo consultant earning $90,000 in accounting profit but who could earn $120,000 at a senior corporate role is generating $30,000 of negative economic profit. The accounting books look fine; the actual choice of how to allocate the consultant's time is destroying value.
EBITDA is widely reported by management teams because it strips out non-cash items (depreciation, amortization) and capital-structure items (interest) to show a "cleaner" operational picture. Real critique: depreciation represents future replacement capex that will happen. Capital-heavy businesses (airlines, refineries, telecom) need that capex to keep operating. Ignoring it overstates sustainable cash generation. Warren Buffett's famous critique: "Does management think the tooth fairy pays for capex?" Use EBITDA as one metric among many, not as a substitute for net income or free cash flow.
Because interest is tax-deductible — businesses are taxed on profit after subtracting deductible expenses. This creates the "tax shield" benefit of debt financing.
Accrual records revenue when earned and expenses when incurred, regardless of cash timing. Cash accounting records only when money actually moves. U.S. GAAP requires accrual accounting for most businesses; small businesses (under $25M revenue) can use cash accounting for tax purposes.
Yes — dividends are distributions from after-tax net income to shareholders. They are NOT tax-deductible to the corporation, which is the double-taxation issue with C-corps.
Individuals use AGI (Adjusted Gross Income), then apply standard or itemized deductions, then arrive at taxable income. Different vocabulary, similar concept — strip out adjustments and deductions to arrive at the tax base.
The proportion of fixed costs in your cost structure. High operating leverage means small revenue changes produce large profit swings (good in growth, painful in downturns).
Non-cash items (depreciation, stock-based compensation), timing differences (accounts receivable, accounts payable), and working capital changes. The cash flow statement reconciles them.
Educational only; not tax or audit advice. Reviewed by Marcus Tan, CPA, on February 22, 2026.