Types of profit: gross, operating, before tax, net and retained, in one worked example

Short answer: a business has one set of figures but several kinds of profit, each taking off one more layer of cost. Gross profit is sales less the direct cost of what you sold. Operating profit (also called EBIT) takes off the running costs too: wages, rent, vehicles, depreciation. Profit before tax takes off loan interest. Net profit (profit after tax) takes off the company’s income tax. Retained profit is what is left after dividends. Each one answers a different question: gross profit says whether your pricing works, operating profit whether the business works, profit before tax what the tax will be charged on, and net profit what belongs to the owners. In Xero, the line called “Net Profit” is usually profit before tax, which is the most common mix-up. Sales itself (turnover or revenue) is not a profit at all; turnover vs profit explains the difference.

The types of profit, from the top of the Profit and Loss down

Profit	How to calculate it	The question it answers
Gross profit	Sales − cost of sales	Do my prices cover what each job or product costs to deliver?
EBITDA	Operating profit + depreciation and amortisation	What does trading earn before the wear and tear on equipment?
Operating profit (EBIT)	Gross profit − operating expenses	Does the business itself make money, however it is financed?
Profit before tax (PBT)	Operating profit − interest paid + interest received	What will tax be charged on (roughly)?
Net profit (profit after tax)	Profit before tax − income tax	What belongs to the owners for the year?
Retained profit for the year	Net profit − dividends or drawings	What did the business keep to grow or to cushion a bad year?

Divide any of them by sales and multiply by 100 to get its margin: gross margin, operating margin, net margin. The margin is what you compare from year to year and with other businesses, because it stays meaningful as sales grow. Operating profit margin shows how to tell whether yours is high enough.

A worked example: an electrical contractor in Perth

These figures are made up. Sam owns an electrical contracting company with five staff. Here is the year to 30 June, worked down from sales to what the company kept.

Year to 30 June	$	% of sales
Sales	900,000	100.0%
Cost of sales: materials and subcontractors	(540,000)	60.0%
Gross profit	360,000	40.0%
Wages and super (including Sam’s salary)	(190,000)
Vans, fuel, insurance, rent, phones, software	(60,000)
Depreciation on vans and tools	(20,000)
Operating profit (EBIT)	90,000	10.0%
Interest on the van loan	(8,000)
Profit before tax	82,000	9.1%
Company tax at 25%	(20,500)
Net profit after tax	61,500	6.8%
Dividends paid to Sam	(40,000)
Retained profit for the year	21,500

EBITDA is the operating profit with the depreciation added back: 90,000 + 20,000 = 110,000 (12.2% of sales). When a small owner-run business is sold, buyers often go one step further and add back the owner’s own pay as well: that is seller’s discretionary earnings.

What each line tells Sam:

• Gross profit, 40.0%. Out of every $100 of work, $40 is left after materials and subcontractors. If that slips to 37%, the business loses 27,000 of profit on the same sales, more than three times the van loan interest. The margin and markup calculator turns a target margin into the price to quote.
• Operating profit, 10.0%. The business is healthy before anyone asks how it is funded. A buyer or a bank looks here first, and it is the line to compare with last year: operating profit shows how it can fall while net profit rises.
• Profit before tax, 82,000. This is the figure the company tax is roughly worked out on (the tax return adds back things like entertainment and some fines, so it is not exact). It is also the figure Xero calls Net Profit for most of the year, because the tax journal is usually posted only at year end.
• Net profit, 61,500. What the year’s work earned for Sam as owner. He paid 40,000 of it out as dividends.
• Retained profit, 21,500. What the company kept. Added to past years, it becomes the retained earnings on the balance sheet, which is not the same as cash in the bank.

And one profit the accounts never show: Sam’s salary is already in wages, but if a manager would cost him 15,000 more plus 12% super (16,800), and the 150,000 he has tied up in the company could earn 5% (7,500) somewhere safer, his true profit before tax is 82,000 − 16,800 − 7,500 = 57,700. The true profit guide explains why that is the number to judge the business on as its owner.

The tax on profits, by country

Which profit the tax is charged on depends on how the business is set up.

• Sole traders and partnerships: the business pays no income tax of its own. The owner pays personal income tax on their share of the profit, so a sole trader’s net profit in Xero is always before tax. Trading profit shows the adjustments from Xero’s figure to the taxable one.
• Australian companies: 25% for a base rate entity (aggregated turnover under $50 million and no more than 80% passive income), otherwise 30%.
• New Zealand companies: 28%.
• UK companies: corporation tax of 19% on profits up to £50,000 and 25% above £250,000, with marginal relief between the two. The corporation tax calculator works out the figure for your profit.

Rates change, so check the current rate with your accountant or the tax office before setting money aside. Profit before tax times the rate is a fair first estimate of what to put away. A year that ends in a loss pays no income tax, and the tax loss can reduce tax in later years (or, for a UK company, earn a refund of last year’s): net operating loss works through both.

Where each one is in Xero

Run Accounting › Reports › Profit and Loss for the year or the last 12 months.

• Gross profit is a line of its own, as long as your direct costs are coded to Cost of Sales accounts. If everything is under Operating Expenses, gross profit will equal sales; Xero gross profit margin shows how to fix that.
• Operating profit is not shown by default. Take Net Profit and add back interest paid (and take off interest received and one-off gains). You can also add a summary row in the report layout editor.
• EBITDA is operating profit plus the depreciation line. The free EBITDA calculator does the sum.
• EBIT is usually the operating profit line; EBIT shows how to work it back from net profit in Xero and use it for interest cover.
• Profit before tax is usually Xero’s Net Profit line until the year-end tax is posted. Check whether an income tax expense account has any figure in it for the period.
• Net profit after tax is Xero’s Net Profit once the tax expense is in.
• Retained profit is on the Balance Sheet: Current Year Earnings for this year, Retained Earnings for past years.

How to read your Profit and Loss walks through each section of the report. Menu names change between Xero releases and regions, so search Xero Central for the report name if your screen differs.

Common mistakes

• Spending profit before tax. If Xero shows 82,000 and nothing has been set aside, about a quarter of it is already owed to the tax office for a company like Sam’s.
• Treating net profit as cash. Loan repayments, equipment, stock and dividends all move cash without changing profit. Profit but no cash shows where the difference goes.
• Comparing different profits. A competitor’s “profit” in an industry report may be EBITDA, while yours is after tax. Check which line before comparing.
• Ignoring the gross margin because net profit is fine. A slipping gross margin is often the first sign of underquoting or rising supplier prices, a year before it shows at the bottom.

Common questions

What are the main types of profit? Gross profit (sales less cost of sales), operating profit (gross profit less running costs), profit before tax (operating profit less interest) and net profit (profit after tax). Retained profit, what is left after dividends or drawings, is often added as a fifth.

What is profit before tax? Profit before tax is what a business earns after every cost, including loan interest, but before income tax. It is the starting point for working out a company’s tax, and in Xero it is usually what the Net Profit line shows until the year-end tax is posted.

What is the difference between gross profit and net profit? Gross profit takes only the direct costs of what you sold away from sales. Net profit takes away every cost, including wages, rent, interest and tax. Gross profit vs net profit has a worked example where one rises while the other falls.

Is operating profit the same as EBIT? For most small businesses, yes: both are profit before interest and tax. Strictly, EBIT can include one-off gains and losses that operating profit leaves out.

How do you calculate profit? Profit is sales minus costs. Take off cost of sales for gross profit, then running costs for operating profit, then interest for profit before tax, then tax for net profit. The free net profit calculator works through it with your own figures.

Which type of profit matters most for a small business? Gross margin and operating profit, tracked every month. Gross margin shows whether pricing works, operating profit whether the business as a whole does. Net profit after tax matters at year end, and profit before tax tells you how much tax to put aside.

Watch the profit lines every Monday

ReportPilot reads your Xero figures and sends a short plain-English email every Monday: how sales, gross margin and profit compare with last month and the same month last year, the cash in the bank, and money owed to you that is past due. It asks Xero for read-only access, and there is a 14-day free trial with no card.