accounting

# Profit formula: How to calculate profit easily

## What is the profit formula?

Calculating profit for a business involves using the profit formula, which is revenue minus expenses.

As a small business owner, you’re likely always looking for ways to boost your income. Whether that’s by increasing sales, eliminating redundancies, or decreasing expenses, you should be looking for the next big cost-saving measure to free up valuable cash flow.

When analyzing the reports from your accounting software to see if your business is on track, you'll want to use the profit formula. This will show you your profit (aka bottom line). Let’s dive into some of the best ways to calculate profit:

## How to calculate profit

Much like a fingerprint, no two businesses are the same. No two companies will have the exact same expenses either. The good news is that the profit equation is fairly straightforward and only requires punching in some variables. The profit formula is:

Profit = revenue – expenses

Revenue is all the money you make from sales. Expenses are everything you spend, from supplies and materials to phone bills and rent.

## Profit formula example

Business owners use the profit formula to see how much income they generate. For example, let’s say you have a boot store that generates \$100,000 in annual revenue. Once you take out the cost of the leather, you have \$80,000 (this is your gross profit).

Next, you take out your operating costs and other expenses, such as the salary of your part-time cashier, the rent, taxes, and utilities. This comes out to \$35,000. Now take the \$80,000 and subtract the \$35,000. This leaves you with a profit of \$45,000.

You can also use the equation for profit to look at the profitability of certain products. For example, your boot store may offer three different product types and find that, although overall company sales are steady, your leather boot sales have declined in recent months. After figuring out the profit for that particular product line, you may decide to discontinue the product.

Once you have the profit formula down, you can use other profit formulas and financial KPIs to see how efficiently you use your resources.

## Different types of profit formulas

When calculating profitability, businesses often look at profit margins. Profit margins are percentages that help measure the profitability of a business and come in different forms, such as gross profit margin, operating profit margin, and net profit margin.

### Gross profit margin

The gross profit margin equation typically helps determine the profit margin of a singular product or service, not of an organization as a whole. The gross profit margin formula is:

Gross profit margin = gross profit / sales x 100

Gross profit is your revenue minus your cost of goods sold (COGS), which includes raw materials. You calculate the gross profit margin by dividing gross profit by revenue. For example, your boot business looks at the retail price of its product and subtracts the cost of materials and labor to produce it. It then divides that by the retail price.

If you sell a leather belt at your boot store for \$25, and it costs \$20 to make, the gross profit margin is 20% (\$5 divided by \$25, then multiplied by 100). Note that it’s a margin percentage, not a dollar amount. This profit percentage can be handy if you want to know exactly what percentage of a sale goes back into your pocket.

FYI: Each industry generally has its own average profit margins due to the differences in costs and materials needed for the different products and services across various industries.

### Operating profit margin

The operating profit indicates how much money the company makes from its core operations after accounting for all operating costs and expenses. The operating profit margin formula is:

Operating profit margin = operating profit / revenue x 100

Operating profit is gross profit minus operating expenses, including administrative and marketing costs. For example, let’s say your boot company has grown into a boot wholesaler, which now generates \$10 million in sales and has operating expenses of \$5 million. The operating profit margin would be 50% (\$5 million in operating profit divided by \$10 million in revenue, multiplied by 100).

### ﻿Net profit margin

Net profit margin determines an entire company’s profit margin—it takes into account all revenue and expenses. The formula for net profit margin is:

Net profit margin = net profit / revenue x 100

Net profit (aka net income) is the final profit figure, calculated by subtracting all expenses from revenue. Continuing with the above example, say your operating profit is \$5 million, but you have \$1 million in other expenses, such as taxes and interest. Your net profit is \$4 million, which means your net profit margin is 40% (\$4 million dividend by \$10 million, multiplied by 100).

FYI: Net profit margin often uncovers a large expense or group of expenses that are hampering company profits. It could also reveal that market demand will support a price increase.

## What’s a good profit?

Now that you have your profit margin in hand, you might be wondering—what is a good profit margin for your business? To start, consider these two factors when assessing your profits:

• Your industry: Not every industry has the same profit margins. For example, an accounting firm can have a profit margin of nearly 20%, while a tech consulting firm may have one of around 10%, with both businesses still being successful in their niche.
• Age of your business: A newer business may have a higher or lower profit margin than the average. It might be lower if the company sells at lower prices to attract customers.

Other factors that affect profit margin include company size, location, production processes, and target audience.

## Best practices: What to do with your profit formula

To get an accurate profit formula calculation, a company must include every expense as part of the total. This includes things like payroll, utilities, inventory management costs, administrative costs, and shipping. Every line item in your accounting ledger that is an expense must factor into your total expenses line item.

Similarly, you must gather all revenue sources as well. Don’t forget nontraditional revenue sources, such as transaction fees or maintenance contracts.

Chances are you have a much clearer picture of your revenue streams than your expenses, but you should still be careful to avoid miscalculations for each amount.

Once you have your profit calculations, it’s time to analyze them and create a strategy. This may include:

• Exploring the options of increasing production or introducing new products: If your profit margin is good, this might be the perfect time to explore growth opportunities. Consider how more production would affect your profit margins. How much would your costs increase? And could you maintain the same profit margin, or would there be a decline?
• Strategizing on ways to improve your profits: If your profits and margins need improvement, it could be time for other changes. You can start by examining ways to increase profit by decreasing expenses. Things like renegotiating contracts, shifting production schedules, or hiring new employees can all affect your revenue and expenses.

In all instances, taking a long look at any sweeping changes that might result from tweaking your profits is a good idea.

For example, although a particular product might not be as profitable as it once was, what are the ramifications of doing away with it entirely? Consider your customers, your employees, and your company’s brand when making any kind of change.

## Streamline your accounting and save time

Using the profit formula to assess your business is something every business owner should do regularly—at least monthly. In particular, the net profit margin is a strong measure of your company’s profitability, looking at how much of your revenue you keep after all expenses.

This process gets much easier if you have accounting software like QuickBooks that makes financial reporting easier.

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