por What are loss and profit?
The utility It is defined as the result of total income minus total expenses, so it is the amount of money that a company «makes» during a given accounting period.
It will be better the more profit is obtained, since the profit can be reinvested in the business or be retained by the owners. On the other hand, if the utility is negative it is considered as loss.
Being able to accurately determine the profit or loss of a business is essential to be able to judge the financial health of the same. It can also help decide how to value goods and services, how to pay employees, etc.
A company’s profit is calculated at three levels on the income statement. It starts with the Gross profituntil reaching the most complete, the net profit. Between these two is operating profit.
These three levels have their corresponding profit margins, calculated by dividing profit by revenue and multiplying by 100.
Calculation of profit and loss
Calculate total income
To find the profit of the business, one must begin by adding up all the money earned by the business in a given period of time.
The total sales of goods or services by the company for the period in question is added. This can come from multiple sources such as products sold, services provided, membership payments, or in the case of government agencies, taxes, fees, etc.
It is easier to understand the process of calculating a company’s profit by following this example. Be a small publishing business. In the past month, $20,000 worth of books have been sold to area retailers.
The rights to one of the intellectual properties were also sold for $7,000 and received $3,000 from retailers, for books as promotional material.
If these account for all sources of income, you can say that your total income is $20,000+$7,000+$3,000, which equals $30,000.
Calculate total expenses
In general, the total expenses of a company mean the total money that the company spends in the accounting period analyzed.
In the example, let’s say the business spent a total of $13,000 during the month in which it earned $30,000. In this case, $13,000 will be used as the value for the total expense.
Subtract Total Expenses from Total Income
After finding the values for the company’s total revenue and expenses, calculating profit is not difficult. Expenses are simply subtracted from income.
The earned value for business profit represents the amount of money that has been earned, or lost, in the specified period of time.
In the example, since the figures for income and expenses are available, the expenses are subtracted from the income, giving: $30,000-$13,000= $17,000 of profit.
Loss as negative profit
If the company generates a negative profit, it means that the company spent more money than it earned during the specified period of time.
Instead of saying that a company has made a negative profit, it is often said that a company has operated at a net loss.
This is something that should be avoided. However, when a business starts, it is sometimes unavoidable. In the event of a loss, a business may have to pay its operating expenses with a loan or raise additional capital from investors.
A net loss does not mean that a business is in dire straits, although that may be the case. It is not uncommon for businesses to make a loss while incurring one-time start-up expenses, buying offices, establishing a brand, etc., until they are profitable.
For example, for nine years (1994-2003) the Internet retailer Amazon.com lost money before turning a profit.
The three levels of utility
Gross profit calculation
Gross profit is defined as all revenue that remains after cost of goods sold is accounted for. These costs include only the expenses directly associated with the production of items for sale.
Gross profit = Sales – Cost of merchandise sold.
To understand gross profit, it is important to know the distinction between fixed and variable costs.
Variable costs are those that vary according to the amount of product manufactured and are incurred as a direct consequence of the production of the product. They include materials, direct labor, freight, etc.
On the other hand, fixed costs are generally static in nature. These include: office expenses, office staff salaries, sales expenses, insurance, rent, etc.
Variable expenses are recorded as cost of merchandise sold. On the other hand, fixed expenses are recorded as operating expenses, also called administrative expenses and sales expenses.
Operating profit calculation
Operating profit takes into account all general, operating, administrative, and selling expenses necessary to run the business on a day-to-day basis.
Operating profit = Gross profit – operating, administrative and sales expenses.
Net profit calculation
This is the bottom line, net income, which reflects the amount of income remaining after accounting for all expenses and income streams.
Debt payments, taxes, one-time expenses, and any income from investments or secondary operations are subtracted from operating profit.
examples
Example 1
For the fiscal year ending October 2023, Starbucks Corp. posted revenue of $21.32 billion. Gross profit and operating profit reach healthy figures of $12.8 billion and $4.17 billion, respectively.
Net income for the year is $2.82 billion. Profit margins for Starbucks would be calculated as:
Gross profit margin= ($12.8 billion / $21.32 billion) x 100= 60.07%.
Operating profit margin= ($4.17 billion / $21.32 billion) x 100= 19.57%.
Net profit margin = ($2.82 billion / $21.32 billion) x 100 = 13.22%.
Healthy gross and operating profit margins allowed Starbucks to maintain decent profits while meeting all of its other financial obligations.
Example 2
Let’s look at ABC Clothing’s gross profit as an example of calculating gross profit margin.
In year 1, sales were $1 million and gross profit was $250,000, resulting in a 25% gross profit margin ($250,000 / $1 million).
In year 2, sales were $1.5 million and gross profit was $450,000, resulting in a 30% gross profit margin ($450,000 / $1.5 million).
Clearly, ABC Clothing earned not only more gross profit money in year 2, but also a higher gross profit margin.
References
What is the formula for calculating profit margins? Taken from: investopedia.com. How to Calculate Gross Profit. Taken from: entrepreneur.com.