Calculating profit is a vital aspect of analyzing your business finances. Knowing how much you’re generating helps you make decisions, craft strategies, and manage your business effectively. It’s also a key metric for understanding the financial health of your business and evaluating performance.
Broadly speaking, profit is the surplus of money left over from a business activity after deducting costs and expenses from revenue for a specific period.
The profit formula is:
Profit = Revenue – costs
- Revenue: The total income generated by your business from its primary operations, such as sales of goods or services.
- Costs: All the expenses your business incurs. This includes variable costs (those that can fluctuate in value such as raw materials), and fixed costs (those that stay relatively constant, such as rent and salaries).
If your calculation produces a positive number, this is considered profit, and it means you’re making more than you spend. If it’s a negative number, it’s considered a loss.
You can adjust this formula to calculate other types of profit.
Net profit calculation
The above example is a net profit calculation, as it includes all revenue and costs. This gives you a comprehensive view of your business’ financial performance, helping you assess its long-term sustainability.
Gross profit calculation
Gross profit is a great indicator of how efficient your business’ core operations are. It reveals how much money is left over when you only consider costs specific to production.
The gross profit formula is:
Gross profit = Revenue – Cost of Goods Sold (COGS)
- COGS: Only costs tied to the production of your goods or services. These would include things like raw materials and labour, but not rent, energy bills, or your taxes.
Operating profit calculation
Operating profit is a more specific way to pinpoint your business’ financial health and the efficiency of your operations. This is because it only considers expenses that are necessary to keep the business running, and not those tied to producing your goods and services.
The operating profit formula is:
Operating profit = Gross profit – operating expenses
- Operating expenses: All costs related to running your business, such as salaries, rent, utilities, and day to day expenditure. It also includes asset-related depreciation and amortization, but doesn’t include things out of your business’ control, like interest payments on loans and taxes.
