Businesses use terms such as gross profit, operating profit and net profit or loss to describe their operations. The operating profit, which is the gross profit minus operating expenses, tells you how much profit your business made, before taxes and certain other items, across all of its product categories and geographies. When you want to know the profit for one or two product items over a period of time an average profit calculation becomes useful.
Businesses have to make choices, often in difficult times. Managers can use the average profitability numbers to see if a product is profitable enough, if a division is making enough money per year or if a product is making money in a particular city or country, for examples.
The average profit is the sum of the profits during each period divided by the number of periods. For example, if a company makes $100, $200 and $300 in the first three years of its business, but loses $200 in the fourth, then the average annual profitability of the company is $100 plus $200 plus $300 minus $200 divided by four, which is equal to $100.
The average profit can be used to gauge how a company is doing through the bad times and the good. For example, a company that had higher average profits than its industry peers over the 2007 to 2010 recessionary period is probably a very well-managed company. If a particular brand is failing to make an average profit, then senior management can decide to discontinue it, or perhaps put in new managers to try to turn the business around.
You can calculate the average profit of the whole business or any part of it. For example, you can calculate the average profit of the operating divisions to gauge how the respective managers are performing. You can also calculate the average profit margin of a product or a business, which is the average profit divided by the average selling price or average revenue. If you are an investor, you could calculate the average profit of your trades during a month, either in a particular stock or across the portfolio, to see if a change in trading strategy is warranted.
The actual profit may not be the same as the actual average profit over prior periods, or the average profit estimate for the current period. For example, Nissan’s fourth quarter loss announcement in mid-May 2010 was quite a bit different than the average profit estimate of at least three research analysts who were expecting the company to make money.