Profit is the amount remaining after expenses are subtracted from revenue. There are three categories of profit: Gross profit, operating profit and net profit. Each one reflects it's own line on the income statement showing where certain categories of expenses have been subtracted from revenues. As such, the financial manager of the business may track performance (changes) for better or worse and harness control, leading the company in the right direction financially.
We use revenue and profit sufficiency as general terms to indicate some minimum threshold of sales and cost savings that allow us to continue running the company and which make doing so worthwhile for the owner. But how much is enough revenue? How much is enough profit? This will change considerably by industry. In free market economies, the market is ultimately the iron fist-ed ruler over over the size of a given industry. A company occupies a position in that space which is either a monopoly, a majority, a part of a pack where there are no majority players, or else a minority player.
In the legal document assistant category there are a several companies out in front of LegalBee in terms of their seniority in the market. Since the entire legal document preparation as a service industry is still in its infancy there is limited data. However, We The People is probably the leading document preparation company which occupies the retail shopfront space and LegalZoom certainly dominates the online scene. the industry is unique in that it is primarily carved out of the larger legal space traditionally occupied by attorneys.
Other things being equal, a company with greater revenue can survive with lessor gross profit percentage than a smaller company. LegalZoom which spends considerably more on below the line advertising expenses (e.g. google ad-words) gets a larger piece from the overall pie for non jurisdictional legal services. However, with jurisdictional legal services, the expertise and access of local presence gives companies like We the People and Legalbee a clear advantage for those items. Internally the most important thing is to compare your company's year to year trends. Your gross profit, operating profit and net profit should show improvement and importantly, as the financial manager you should understand the underlying reasons for the changes in your company's numbers.
Let's assume that you have charted your gross profit a graph and notice that there is a downward trend over the past three years. this should prompt you to ask questions. Have production costs risen? Salary increases, the cost of paper, etc. Is the price point of your service too low, or has there been too much discounting of sales? As gross profit changes you are able to look at the particular numbers to understand why.
There is also the possibility of bias in the numbers if say your accountant decides to reassign salaries like say your sales manager's from operating expenses line and reassign it to above the line expenses, i.e., COS. Such a change would lowergross profit by increasing the cost of services arbitrarily. You accountant might think that such changes are immaterial and forget to mention them, so communication is important. In such an instance you would want to ask him or her why she moved that salary and why you were not informed of the change. But now at least you know that costs did not really go up and that there is no need to lay anyone off.. If that salary is to remain on COS than perhaps the target number for gross profit needs to be lowered. But nothing else really needs to be changed.
Operating profit is gross profit minus operating expenses. The number should reflect administration and general expense such as rent, utilities and so on. For most LegalBee operations the number will not fluctuate unless the operation is aggressively scaling up or there is a significant change in management salary. There will be seasonal cyclical changes for utilities and the like.
EBIT or earnings before interests and taxes is just another name for operating expenses. the reason interests and taxes are not considered operating expense is that they have nothing to do with the actual costs to run the business. Thefinancial structure of the company has nothing to do with how it is being run from an operational perspective. If the company is financed with debt this is an additional item which must be subtracted from revenues to come to net profit. Remember that operating profit is the profit that the business has from the business it is in. The same thing holds true for taxes. Taxes are not an operational item So both interest and tax payment items must have their own respective lines.
Operating profit is like a report card that tells potential investors, the bank and others who might look at the health of your business how well the business is doing. It shows if the business is able to pay its obligations and it includes amortization and depreciation of assets. This is really where the profit is shown from running the business. Back end expenses from inefficient operations bloated owner's salaries and the like show up in this space. Operating profit shows the overall demand for the service int he market and the costs involved for delivering the document preparation service. Items to pay particularly close attention to areone time charges and how depreciation has been determined. Assets on financial statements almost never reflect their true value.
Sales and Marketing is given its own line on the income statement because thelegal document assistance industry has a greater than average customer acquisition cost. If you are spending forty dollars for COS on a hundred dollar sale, you may expect to spend another twenty dollars for sales and marketing. As a percent of revenue, 20% or even higher is not unusual for this industry. More on marketing in the marketing module.
The bottom line on the income statement is net profit. this is the sum left over after everything else is subtracted. This includes cost of service, operating expense, non cash expenses such as amortization and depreciation, sales and marketing expense, one time charges, and interest and tax payments. What if your Legalbee operation has a net profit that is lower than it should be? We recommend a target net profit of greater than or equal to 8%. This number allows for retained earnings to capitalize future growth, replacement of office furniture, and periodic remodeling to keep your the LegalBee brand fresh and appealing. This target range also allows a nice return of 2 to 3% profit that can be used as bonus for all of your hard work!
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