What is a business profit? Business profit refers to the excess of the business’ total income less all expenses within the accounting period, which may be presented monthly, quarterly or annually. However, please be informed that a loss, instead of a profit, will be the result if the total expenses exceed the total income of the business. For all business owners, profits are important in order for their business to survive. In the first place, unless you’re in to charity, do you know anyone who wants to conduct business without making profits?
As business owner, you must have a good understanding of your business’ financial statements. If you’re not, you may need a professional help from people whom you can get a good accounting and financial advice – they are generally referred to as Accountants. They can review your financial statements and can also provide valuable advice on how to improve your accounting records.
So how do you compute your business profit? The simplest formula is:
Total Income – Total Expenses = Net Profit
• Total income generally includes revenues or sales of goods or services to customers. It may also include income from deposits, investments and any other revenue sources such as interest, royalties, dividends, and gains on exchange of properties.
• Total expenses includes all costs or expenses related to the sale transactions such as production costs, marketing and all other cost and expenses related to your business operations including depreciation, losses, taxes, and interest on debt.
In simple term, profits are all the incomes you earned from your business less all the expenses you’ve incurred to run the business.
In addition, for presentation purposes, I would like to emphasize three presentations on how to calculate profit based on the three types of business. In general, there are three common types of businesses based on their operation in the market, namely, service business, merchandising business, and manufacturing business.
Computation of profit on service businesses
Service firms are businesses that provide services instead of product to its customers. Computation for its profit is simpler because it is known that service type business does not carry inventory, thus, it does not have a computation for cost of goods sold. The following is a sample outline for the computation of the profit of a service business.
*Other operating expenses can be further classified as general and administrative expenses. They are the expenses incurred by the business during the accounting period which are not directly related to the service income earned, such as income taxes.
Computation of profit on merchandising businesses
Merchandising businesses are businesses that enter into retail and trading of its products. One characteristic of this type of business operation is that they don’t produce or manufacture their own products to sell. Instead, they purchase its products from other business and then sell it to customers with a mark-up from its purchase price. As such, it will be observed that the computation of its profit involves calculation for its cost of goods sold but do not compute for the cost of goods manufactured. Below is a sample computation of net profit or net income of a merchandising business.
• Beginning Inventory – inventories you have in your business at the beginning of the period that are available for sale.
• Purchases – inventories you bought during the current period.
• Direct costs – costs incurred that can be directly identified or attributed to the merchandising of the product such as freight-in and inventory storage costs.
• Ending Inventory – inventories you have in your business at the end of the period that has not yet been sold to customers.
Computation of profit on a manufacturing business
Manufacturing businesses are those that produce or make their own products then sell it to their customers. The computation of their profit is the same with merchandising type of business operation. However, the cost of goods sold section for a manufacturing business is more complicated. The major difference here is obviously in the need to know how to compute cost of goods manufactured. Furthermore, the manufacturing type of business operation’s inventory that is sold is called finished goods rather than being called simply an inventory and cost of goods manufactured has replaced inventory purchases. The following is the format of computing the net profit or net income of a manufacturing business:
Whenever you manufacture your own product, additional elements are entered into the cost. You’ll have material costs, direct labor, and some overhead costs to convert raw materials to finished goods. A manufacturing company has three inventories namely raw materials, work in process inventory, and finished goods inventory.
• Raw materials consist of all the materials you bought to make your products.
• Work in process is all your products that you are in the middle of making at the end of the period.
• Finished goods inventory is the value of all completed products that are not yet sold to customers
Now that you have an idea how to compute your business profit, my next question is which type of business operations your business falls under?