HOW ARE PROFIT AND LOSS CALCULATED? (WITH EXAMPLES) - DUDAS - 2025

Profit 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.

The better the more profit you get, since the profit can be reinvested in the business or retained by the owners. On the other hand, if the profit is negative it is considered as a loss.

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Being able to accurately determine the profit or loss of a business is essential to be able to judge its financial health. It can also help you decide how to evaluate goods and services, how to pay employees, etc.

The profit of a company is calculated in three levels in the income statement. It starts with gross profit, until reaching the most complete, net profit. Between these two is operating profit.

These three levels have their corresponding profit margins, calculated by dividing profit by revenue, and multiplying it by 100.

Profit and loss calculation

Calculate total income

To find the profit of the business, you should start by adding 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 are 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 the profit of a company by following this example. Be a small publishing business. In the last month, books worth $ 20,000 were sold to retailers in the area.

The rights to one of the intellectual properties were also sold for $ 7,000 and received $ 3,000 from the retailers, for books as promotional material.

If these represent all sources of income, it can be said that the total income is $ 20,000 + $ 7,000 + $ 3,000, which is equal to $ 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 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 income and expenses, calculating profit is not difficult. The expenses are simply subtracted from the income.

The value obtained for the profit of the business represents the amount of money that has been made, or has been lost, in the specified period of time.

In the example, since we have the income and expenses figures, the expenses are subtracted from the income, giving: $ 30,000- $ 13,000 = $ 17,000 of profit.

Loss as negative profit

If the business generates a negative profit, it means that the business spent more money than it earned during the specified time period.

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 company may have to pay its operating expenses with a loan or obtain 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 losses while incurring one-time startup expenses, buying offices, establishing a brand, etc., until they are profitable.

For example, for nine years (1994-2003) the Internet marketer Amazon.com lost money before it began to make a profit.

The three levels of utility

Gross profit calculation

Gross profit is defined as all revenue remaining after costs of merchandise sold are 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 quantity 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, selling expenses, insurance, rent, etc.

Variable expenses are recorded as costs of merchandise sold. On the other hand, fixed expenses are recorded as operating expenses, also called administrative expenses and sales expenses.

Calculation of operating profit

The operating profit takes into account all the general, operating, administrative and sales expenses necessary for the operation of 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 ended October 2016, 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. The 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%.

The net profit margin = ($ 2.82 billion / $ 21.32 billion) x 100 = 13.22%.

Healthy gross and operating profit margins enabled 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 gross profit margin of 30% ($ 450,000 / $ 1.5 million).

Clearly, ABC Clothing made not only more money from gross profit in year 2, but also a higher gross profit margin.

References

1. Investopedia (2018). What is the formula for calculating profit margins? Taken from: investopedia.com.
2. Entrepreneur (2013). How to Calculate Gross Profit. Taken from: entrepreneur.com.
3. Wikihow (2019). How to Calculate Profit. Taken from: wikihow.com.
4. Steven Bragg (2018). Profit formula. Accounting Tools. Taken from: accountingtools.com.
5. Investing Answers (2019). Operating Profit. Taken from: investinganswers.com.