Profit as a final financial result of enterprise
Definition and classification of enterprise income.
Revenue of the company – is total revenue, which enterprise receives as a result of entrepreneurial activity over some time period (year, quarter, month).
According to Accounting Standard № 15 "Revenue" enterprise revenue is classified into the following groups:
a) Revenue from products (goods and services) realization;
b) other operating revenue;
c) financial revenue;
d) other revenue.
e) extraordinary revenue.
Revenues related to each group are set by Accounting Standard № 3 "Income Statement".
Revenue from products (goods and services) realization is determined as total revenue from sale of products, goods or services, without deduction of provided discount, return of goods sold and indirect taxes (VAT, excise, etc.).
Net income from products (goods and services) realization is determined by deducting from total revenue from products (goods and services) realization taxes, fees, discounts etc.
Other operating revenue is operating revenue of enterprise, except revenues from products (goods and services) realization. It includes revenue from operating lease of assets; operating revenue from exchange rate differences; compensation of previously written-off assets, revenue from sale of current assets (excluding financial investments) and others.
Other operating revenue is:
- Revenue from operating lease of assets;
- Operating revenue from currency exchange fluctuations;
- Revenue from the sale of foreign currency;
- Received fines, penalties;
- Revenue from charges accounts payable;
- Received grants and subsidies;
- Other operating revenue.
Return on equity is revenue received from investments in associates, subsidiaries or joint ventures which are accounted by participation in equity method.
Profit as a final financial result of enterprise.
Income is a part of financial result, that remains after company’s refund of all costs associated with production, sales and other types of activity.
Profit (income) of entity is an indicator of its economic activities financial results, determined by reducing the amount of entity’s gross income on amount of gross expenditures and the amount of depreciation and amortization for a certain period of time.
In market conditions income is the source of all financial resources of enterprise.
Profit reflects the main purpose of enterprise existence on market and business profile.
The role and place of profit in the system of economic relations
| Role and functions of profit | Contents of functions |
| The internal source of financial resources | Income plays a leading role in system of internal sources of enterprise financial resources. The higher level of income generation in process of enterprise economic activity is, the less is its need to attract funds from external sources and with other things being equal - the higher is the level of its development self financing, implementation of strategic goals of this development, increasing of competitiveness and ability to maintain leading market position. Thus, unlike some other sources of internal financial resources of company, profit is a source, which is constantly reproduced on an extended basis. |
| Base of national economy economic development and state in general | Mechanism of profit redistribution through the tax system allows to fill a profitable share of state budgets at all levels, enabling the country to carry out its functions and carry out the planned program of social and economic development successfully. In addition, the implementation of generally accepted principle - "the level of state development is characterized by income of its citizens" - is also associated with increasing profits, which provides rising incomes of its owners, staff and management personnel. |
| The main goal of enterprise business | The main motivation of any kind of business, its primary ultimate goal is the growth of owners wealth. The size of current and future profits on invested capital, which is a source of extra profits is a characteristic of this growth |
| The main mechanism to prevent financial bankruptcy and insolvency of enterprise | Profit is the main protective mechanism that prevents the company from the threat of bankruptcy. Such a threat may occur even in conditions of profitable economic activity, but when other things being equal, company with a high potential for generating profit will come out of crisis the most successfully. Part of liquid assets and equity can be rapidly increased by profit capitalization with a corresponding reduction of loans and credits; reserve funds can be also formed. |
| The main criterion of economic activity efficiency and appropriate management decisions taking | Individual level of enterprise profits in comparison with the industry level describes an ability (skills, qualification, professionalism, training, experience, initiative) of management to carry out business successfully in market economy. Average industry level of enterprise income characterizes market and other external factors, that influence the efficiency of production activity and is the main regulator of “overflow of capital” process to sectors with higher levels of it’s use. |
| Source of social needs and demands of society satisfaction | Profits of an enterprise is the most important source of social needs satisfaction. Social role of profit appears primarily in fact that funds transferred to the budgets of different levels in the process of taxation, is a source of variety of national and other social programs that ensure survival of some socially not secured strata of population. In addition, this role appears in satisfaction enterprise staff needs from profit got by enterprise. Some social role of income is in it serving as a source of charitable activities of the enterprise, which aims to fund activity of unprofitable organizations, social institutions, providing financial assistance to certain categories of citizens. |
| Source of financial providing of enterprise market value growth | An ability to stimulate growth of enterprise capital from inside is provided by capitalization of part of income received, that means its orientation on growth of assets. The higher amount of profit capitalization is, the more increase of enterprise net assets and its value is. |
Classification of income
| Classification feature | Type of profit |
| The purpose of defining | Economic profit |
| Accounting profit | |
| The economic nature of income | Profit from sale of products (goods and services) |
| Profit from sale of property | |
| Income from non-realization operations | |
| Sphere of origin (types of business that are sources of profit) | Operating Profit |
| Profit from investing activity | |
| Profit from financing activity | |
| The method of calculation (content of income and expenses used while profit calculating) | Marginal profit |
| Gross (book) profits | |
| Net profit | |
| Character of income and expenditure ratio | Profit (surplus) |
| Loss (excess of expenditure over income) | |
| The nature of taxation | Income taxable |
| Income not taxable | |
| Relation to the moment of taxation | Profit before taxation |
| Profit after taxation | |
| Considering the impact of inflationary factors on profit margins | Nominal income |
| Real income | |
| Periodicity of appearing | Income from individual transactions |
| Profit from periodically operations | |
| The period of assessment | Short-term profit |
| Mid-term profit | |
| Long-term profit | |
| Regularity of appearing | Planned profit |
| Profit from extraordinary items | |
| The historical character of appearing | Profit of prior period |
| Profit of reporting period | |
| Profit of planning period | |
| Possible use | Capitalized (undistributed) profit |
| Distributed profit | |
| Structure of sources of appearing ("Quality of earnings") | Profit of high quality |
| Profit of average quality | |
| Profit of poor quality | |
| The level of assessment | Profits of an enterprise |
| The profit of the branch | |
| Object of assessment | Profit from enterprise activity |
| Income from production and sale of goods (nomenclature or assortment groups) | |
| Profit from carrying out business transactions |
Classification of income depending on types of business, according to financial statements:
Operating profit - the value on which income from operations (revenue from the sale and other operating income) exceeds the current costs associated with this activity (cost of sales plus administrative costs plus costs of products realization and other operating expenses).
Gross profit (loss) is calculated as difference between net income from sales of products (goods and services) and their cost.
Marginal profit is the value, which is defined as the difference between revenue and variable operating costs of enterprise, covers enterprise fixed costs and let to get profit as the final financial result.
Net profit is a profit that is available to enterprise after payment of income tax.
Figure Reserves of enterprise profitability increase
3. Essence of profitability.
Absolute amount of enterprise profit does not allow analyzing effectiveness of enterprise functioning or level of attractiveness of individual type of product.
Profitability is a relative index that characterizes the level of efficiency of enterprise work.
The following types of profitability are distinguished:
- Return on sales;
- Return on assets;
- Return on equity;
- Return on investment;
- Profitability of activity;
- Profitability of products.
Return on sales is calculated as the ratio of net profit to net revenue from sales and characterizes the efficiency of enterprise sales.
Return on assets is calculated as the ratio of net profit to average assets value and characterizes the efficiency of assets use.
Return on equity is calculated as the ratio of net profit to the average annual cost of equity and characterize efficiency of investment in this company.
Return on investment is calculated as the ratio of net profit and paid interest to the amount of personal and long-term debt capital for middle period. Shows, which return on equity have owners and holders of long-term debt.
Profitability of production is calculated as the ratio of profits from sales to the cost of products and characterizes economic activity profitability from operations.
Profitability of operational activity is measured as the ratio of operating income to operating expenses.
For joint-stock companies, whose common shares are traded publicly on stock exchanges, including partnerships that are in the process of issuing such shares, indexes of shares profitability should be calculated and analyzed.
Information on common shares can be found in the third section of report on the financial results of enterprises.
Net profit per one ordinary share is an index, which is calculated by dividing net profit or loss, which belongs to the owners of common shares, on average number of diluted shares.
Dividends per ordinary share - is an index, calculated by dividing the amount of dividends declared by the number of shares on which dividends are paid.
There are no set boundaries of profitability, and the main factors increasing profitability can be the following:
a) while assessing production profitability: increase of profit, reduce the cost of fixed assets and remains of normalized current assets;
b) while assessing the profitability of individual products: lower cost of products.