How To Calculate Profit (With Example)
Profit means success for a business, and executives should be able to calculate that bottom line. Analysts use profit as a measure of a business's worth, helping investors make appropriate decisions. In some cases, individuals may be required to use basic math to calculate profit on their own. In this article, we discuss what profit is and what it says about a business, and then we provide an example of how to calculate profit.
How to calculate profit
The formula to calculate profit is: Total Revenue - Total Expenses = Profit. Profit is determined by subtracting direct and indirect costs from all sales earned. Direct costs can include purchases like materials and staff wages. Indirect costs are also called overhead costs, like rent and utilities.
For businesses, profit is often calculated by profit margin formula:
(( Revenue - Cost of goods) / Revenue)*100.
Read more: How to Calculate a Profit Margin Ratio
Example of profit calculation
Finding profit is simple using this formula: Total Revenue - Total Expenses = Profit. For example, Francis wants to find out how much money they’ve made in their dog walking business. They need to know their total revenue and total expenses to calculate their profit.
Total revenue: $10,000
Total expenses: $1,500
Francis’ total expenses are calculated by adding their direct and indirect costs, as follows:
Direct costs, such as dog treats: $1,000
Indirect costs, like posters and flyers: $500
Total expenses: $1,000 of direct costs + $500 indirect costs = $1,500
By subtracting $1,500 of total expenses from their total revenue of $10,000, Francis can calculate that their profit is equal to $8,500.
Calculating profit FAQ
What is profit?
Profit is a term that often describes the financial gain a business receives when revenue surpasses costs and expenses. For example, a child at a lemonade stand spends one quarter to create one cup of lemonade. She then sells the drink for $2.00. Her profit on the cup of lemonade amounts to $1.75. The term can sometimes be a bit more complex as there are three types of profit:
Net profit: When a business subtracts all their costs from their generated revenue, they are left with their net profit. It's the most vital component of an income statement and what many executives and analysts look for. Businesses use their net amount to determine how much money they make in a given period. Net profits contain non-cash elements as well. These elements are excluded from operating profit.
Gross profit: When a business subtracts their costs of goods sold from their generated revenue, they are left with their gross profit. It's an important figure when studying analyzing their income statement. Businesses use this amount as an indicator of their profit before expenses. Gross margins must remain high to afford operating expenses. The optimal percentage for gross profit is 30% or higher. This standard percentage is sufficient to cover most business' taxes and other expenses.
Operating profit: This is the total profit of business operations. It's determined by only subtracting operating expenses from gross profit and includes interest and taxes. Operating profits are considered a decent measure for understanding how efficient business operations are.
What does profit say about a business?
The ultimate goal of a business is to make money. Because of this, many companies measure their performance by their profitability. Some executives and analysts only interest themselves in the top line, while many others focus on watching and improving on the bottom line. Each of the three types of profit listed above gives those individuals a clear sense of performance. When considering acquisition options, they will use profitability as a comparative metric in making their final decision.
What is profitability?
Profitability and profit are similar terms, differing in a single way. For a business's sake, profit has to be a specific amount. Profitability, however, refers to a relative amount. It determines the business's profit by comparing it to the size of the entity. Profitability can be used to measure how efficient financial operations are run. It's how well a business can produce a return on investment. This is measured by comparing resources with those required in another investment.
Related: Learn About Being a Business Analyst
Profit vs. revenue
Profit and revenue may appear similar, but they actually stand at opposite ends of the income spectrum. Profit, often called the bottom line, accounts for all expenses. Revenue, often called the top line, is the total amount of sales income. Revenue is reported at the top of an income statement, hence its secondary name. It's recorded in accounting at the time the purchase of the good or service is made, whether they receive money at that moment or not. Alternatively, profit is reported at the bottom of an income statement. It's often the most important number for executives and investors.
Profit vs. profits
While researching the concept of profit, the plural and singular forms of the word appear interchangeable. In some cases, it's simply a regional difference. For example, British business literature tends to use the plural form more often. However, some business experts argue that the singular form is related to accounting. They believe it refers to the difference between price and cost. Alternatively, those same experts believe that the plural form is related to economics. They describe it as the financial benefits a company gets from an investment. It occurs when total returns surpass the amount of invested capital.
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