How To Calculate ProfitWith formulas and examples

The primary purpose of starting and running a business is to earn profits.

There are various ways in which a business can earn profits.

Some sell a plethora of goods, while some only sell a specific brand or type of product.

There are also those that manufacture the products that they sell.

Some perform services such as repairs, maintenance, cleaning, etc.

Of course, there are also businesses that sell both goods and services.

Whatever these businesses earn from their product offerings becomes their revenue.

However, in order to earn their revenue, businesses usually have to incur certain costs to make the sale.

These costs that we can directly attribute to the sale of goods and services are what we refer to as the cost of sales (a.k.a. cost of goods sold, cost of services).

But of course, these costs are not the only costs that businesses.

There are still other costs of operations such as the salaries and wages of the admin staff, rent of office building, etc.

We usually refer to these costs as operating expenses.

And finally, there are other expenses that are not necessarily related to the operations of a business but they can still be incurred by one.

Examples of such expenses include interest and taxes on income. We refer to these expenses as non-operating expenses.

After deducting all these costs/expenses from the revenue, we finally arrive at the business’s profit.

Essentially, profit is what’s left of revenue after deducting all expenses… sort of.

As it turns out, the term profit can refer to different things.

It could also be the difference between revenue and cost of sales (i.e. gross profit).

In this article, we’re going to find out what these “things” are as well as how to calculate them.

Calculating Profit

Net Profit

Let’s talk about this first: what is “profit” exactly? As I’ve mentioned above, the term profit can refer to different things.

But when people talk about profit, they usually refer to net profit (a.k.a. net income).

It is the profit that a business or individual earns after deducting all expenses (including income tax) from the revenue.

Net income can either be distributed as dividends to shareholders, could be retained by the business for growth, or can be a mix of both.

The formula for calculating net profit is as follows:

Net Profit = All Revenue – All expenses

-or-

Net Profit = Revenue – Cost of Sales – Operating Expenses + Non-Operating Income – Non-Operating Expenses

The first formula is a more simplified version while the second expounds on it.

Revenue refers to earnings from the business’s core operations.

Cost of sales refers to expenses that are directly attributable to the sale of goods or services.

Operating expenses refer to those that a business incurs in its operations but are not directly attributable to the sale of goods or services.

Non-operating income refers to earnings from non-operating sources.

Likewise, non-operating expenses refer to those that aren’t directly attributable to the operations of the business.

With the net profit, we can also calculate the net profit margin (a.k.a. after-tax profit margin):

Net Profit Margin = Net Profit ÷ Net Revenue

The net profit margin gives an idea of how well the business controls its costs.

It’s presented in percentage form.

Gross Profit

The gross profit is the figure we arrive at after deducting a business’s cost of sales from the revenue.

It’s an important figure as it tells us how much a business is earning from its sales.

It also tells us if the business is implementing a proper pricing strategy.

Ideally, the gross profit should be a positive figure.

If it’s zero or negative, it means that the business is losing money rather than earning from its sales.

And that’s disastrous because gross profit is usually the source for the payment of other expenses.

The formula for calculating gross profit is as follows:

Gross Profit = Revenue – Cost of Sales

If the business has sales returns, allowances, and discounts, those should be deducted from the revenue too.

With the gross profit, we can also calculate the gross margin:

Gross Margin = Gross Profit ÷ Revenue

The gross margin gives us an idea of the profitability of the business’s offerings.

The higher it is, the more profitable the business’s goods or services are.

Operating Profit

The operating profit is what we get after deducting all operating costs (cost of sales and operating expenses) from the revenue.

It tells us how efficient the main operations of the business are.

It also tells how much the business earns from just its main operations.

This is an important figure for business owners as the business’s main operations are the main source of its earnings.

The formula for calculating operating profit is as follows:

Operating Profit = Gross Profit – Operating Expenses

-or-

Operating Profit = Revenue – Cost of Sales – Operating Expenses

The first formula assumes that the gross profit has already been calculated while the second one starts from the revenue.

With the operating profit, we can also calculate the operating margin:

Operating Margin = Operating Profit ÷ Revenue

The operating margin gives an idea of the efficiency of the business’s operations.

Profit Before Tax

Profit before tax refers to what the business earns after deducting all expenses from the revenue except income tax.

It is the basis of computation for income tax (after applying the proper adjustments for income tax).

While it’s not as emphasized as the other profitability measures, it’s still a useful figure, especially for comparison.

The formula for calculating profit before tax is as follows:

Profit Before Tax = Operating Profit + Non-Operating Income – Non-Operating Expense (Except Income Tax)

-or-

Profit Before Tax = Revenue – Cost of Sales – Operating Expenses + Non-Operating Income – Non-Operating Expense (Except Income Tax)

How to Calculate Profit: Example

To further our understanding of the several profit formulas, let’s have an example.

Let’s assume that you own a business.

Your business earns $530,000 in revenue for the current year.

Here is a breakdown of the expenses that the business incurred to earn such revenue:

• Cost of Sales – $238,500
• Operating Expenses – $190,000
• Interest Expense – $12,000
• Income Tax – $18,795

With this information, let’s calculate the different profitability measures of your business.

We’ll start first with the gross profit:

Gross Profit = Revenue – Cost of Sales

= $530,000 – $238,500

= $291,500

As per our calculation, your business’s gross profit is $291,500.

Next, we’ll proceed with the calculation of operating profit:

Operating Profit = Gross Profit – Operating Expenses

= $291,500 – $190,000

= $101,500

Our calculations say that your business has an operating profit of $101,500.

The next profitability measure we’ll be calculating is the profit before tax:

Profit Before Tax = Operating Profit + Non-Operating Income – Non-Operating Expenses (Except Income Tax)

= $101,500 + $0 – $12,000

= $89,500

With that, we find out that your business’s profit before tax is $89,500.

Finally, we’ll calculate the net profit of your business:

Net Profit = Profit Before Tax – Income Tax

= $89,500 – $18,795

= $70,705

And there we have it. Your business net profit for the current year is $70,705.

Here’s what the calculation for net profit will look like if we don’t calculate the other profitability measures:

Net Profit = Revenue – Cost of Sales – Operating Expenses + Non-Operating Income – Non-Operating Expenses

= $530,000 – $238,500 – $190,000 + 0 – ($12,000 + $18,795)

= $530,000 – $238,500 – $190,000 + 0 – $30,795

Net Profit = $70,705