Describe the difference between gross profit and income from operations. Why would a company be concerned with gross profit rather than just overall income from operations?
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SOLUTION to ACC 240: Fundamentals of Accounting- Topic 4 DQ 1.
Hello class,
After rigorous research, I found out that gross profit and income from operations are important profitability metrics calculated at different stages of a company's income statement. Gross profit is the excess of revenues over the direct costs associated with producing the goods and services sold to generate those revenues. It is calculated as revenues minus the cost of goods sold (Jayathilaka, 2020). Thus, gross profit reflects profits made after direct production costs but before operating expenses are considered. Conversely, income from operations, which is also called operating income, goes a step further by deducting all operating expenses like sales, administrative costs, and depreciation from the gross profit figure. As a result, it represents the profits earned through actual business operations before including any non-operating, non-recurring, or interest and tax items (Jayathilaka, 2020).
Additionally, I learned that there are a few key reasons why companies closely monitor gross profit in addition to operating income. First, analyzing gross margins can reveal the true costs of production and the effectiveness of procurement and supply chain management over time. This has direct implications for pricing strategies since the cost of goods sold is a controllable expense. Moreover, higher gross margins also translate to more flexibility in covering operating expenses which are often fixed costs that fluctuate less in the short run (Fonseca et al., 2022). This means that gross profit acts as a cushion against unforeseen expense increases or revenue declines from macro factors that are beyond the control of a company like economic downturns.
Finally, gross profit separates the assessment of production efficiency from the governance of discretionary overhead costs (Jayathilaka, 2020). This helps pinpoint where value is generated within distinct business processes to improve resource allocation and boost profitability at the source. Therefore, I believe optimizing gross margins receives considerable focus from managers too in addition to net operating income.
References
Fonseca, S., Guedes, M. J., & da Conceição Gonçalves, V. (2022). Profitability and size of newly established firms. International Entrepreneurship and Management Journal, 18(2), 957-974. https://doi.org/10.1007/s11365-020-00730-6
Jayathilaka, A. K. (2020). Operating profit and net profit: measurements of profitability. Open Access Library Journal, 7(12), 1-11. https://doi.org/10.4236/oalib.1107011