Book ProfitDefined along with Formula & How to Calculate

The main purpose of starting and running a business is to generate profit.

It is what you earn after considering all the expenses that you’ve incurred.

Running a business comes with certain expenses after all.

There’s the cost of making the sale.

Then there are operating expenses.

Even after that, there are non-operating expenses such as interest and taxes.

After considering all those expenses, if there’s still something left of your revenue, then you have profit.

Profit is important for business growth.

You can continue to inject cash into your business to facilitate growth, yes.

But that’s merely a transfer of resources. There really is no growth in such an activity.

But of course, just knowing what profit is or feeling that your business made a profit isn’t enough.

You need a concrete figure on how much profit your business has earned.

That’s where accounting comes in.

In this article, we will be learning about what book profit is.

We will learn its definition as well as the role it plays in your business.

What is Book Profit?

We can define book profit in two ways.

First, it is the profit that appears on a business’s books and/or income statement.

Simply, book profit is what you get when you deduct all expenses from a business’s revenue according to what was recorded in the business’s books.

Generally, book profit refers to a business’s financial income before taking taxes into account.

The other definition of book profit is that it refers to profit that is only on paper.

Meaning that there’s “profit” but no corresponding cash inflow.

Following this definition, we can also refer to book profit as paper profit (loss) or unrealized gains (losses).

For the rest of the article, we will be using the first definition when referring to book profit.

(For more info about the second definition, you can refer to this article.)

The formula for computing book profit is quite simple.

It is as follows:

Book Profit = Revenue – Expenses

In the formula above, revenue not only refers to revenue that comes from the business’s main operations.

It also includes income from non-operating activities (e.g. income from investments, financing activities, etc.).

In a way, we can expound revenue into revenue (from operations) plus other income.

The “expenses” component above refers to all the expenses that the business has incurred.

This includes the cost of sales, operating expenses, and non-operating expenses.

The cost of sales refers to the expenses directly attributable to the generation of revenue.

Operating expenses refer to expenses that the business incurs as it continues to operate.

Lastly, non-operating expenses refer to other expenses that the business incurs such as finance charges (interest expense) and taxes.

While book profit generally refers to pre-tax income, it can also refer to a business’s after-tax income.

Understanding Book Profit

The calculation of book profit is largely based on GAAP (Generally Accepted Accounting Principles).

This means that it follows the accrual method of accounting.

Revenue and expenses are not recorded based on when cash is received or spent.

Rather, revenue is recorded when it is earned, and expenses are recorded when they are incurred.

This means that revenue is not exclusive to cash sales. Likewise, expenses are not exclusive to cash expenses.

Book profit, when accounted for properly, represents a business’s profitability.

It gauges a business’s financial performance for a certain period.

In general, the higher the book profit is, the better it is for the business.

Book profit is useful for comparison with other businesses as it is calculated according to widely-used accounting standards (e.g. the GAAP).

It also complies with the requirements of certain government agencies (e.g. SEC).

By complying with the GAAP, book profit provides a business’s stakeholders (owners, investors, creditors, employees, the general public) with an easy to digest information about its profitability.

Book Profit vs Taxable Income

Book profit may not always equal a business’s taxable profit (or taxable income).

This is because certain revenue and expense items are interpreted differently between the two.

For example, for tax purposes, MACRS is the only allowed method of depreciation.

This creates a discrepancy in the depreciation figure if the business is employing a depreciation method other than MACRS for financial accounting.

Also, some expense items are not deductible for income tax purposes.

For example, representation or entertainment expenses are non-deductible expenses.

Due to the differences in interpretations, it is usually the case that book profit is not equal to taxable profit.

Hence why some accountants prepare certain reconciling entries to convert book profit into taxable profit.

Taxable profit is the basis for the computation of a business’s income tax liability.

It is the net profit/income figure that you’ll see on a business’s tax return.

The calculation of taxable profit as well as income tax is based on the tax law.

Since taxable profit is based on another standard (IRS rules), any changes to the GAAP do not affect it.

Instead, any changes to tax laws affect it.

As such, even if a business performs at the same level over several periods, its taxable income may still vary due to changes in the tax law.

For example, an expense item that was previously non-deductible may become deductible.

Example of Book Profit Calculation

Company CD has the following revenue and expense figures:

• Total cash sales – $330,000
• Total credit sales – $787,000
• The Total cost of sales – $670,800
• Total operating expenses – $278,660

In addition, it has the following other income and expense figures:

• Other income – $185,300
• Other expenses – $77,410

With these figures, we can compute for company CD’s book profit. Remember that the formula for the computation of book profit is as follows:

Book Profit = Revenue – Expenses

First, let’s compute the revenue figure.

To compute the revenue figure, we need to identify the revenue items.

From the information above, we gather the following revenue items:

• Total cash sales – $330,000
• Total credit sales – $787,000
• Other income – $185,300

With this information, we can proceed with the computation of the revenue figure:

Revenue = $330,000 + $787,000 + $185,300

= $1,302,300

Next, we need to compute the “expenses” figure. Same with what we did with the revenue figure, we need to identify the expense items first.

From the information above, we gather the following expense items:

• Total cost of sales – $670,800
• Total operating expenses – $278,660
• Other expenses – $77,410

We can now proceed with the computation of the expense figure:

Expenses = $670,800 + $278,660 + $77,410

= $1,026,870

Now that we have both components, let’s proceed with the computation of the book profit:

Book Profit = Revenue – Expenses

= $1,302,300 – $1,026,870

= $275,430