How do I calculate profit in my business and why should I?
Why should you calculate profit?
Profit in a business determines both how well your business is performing and how much you can extract from your business personally or reinvest to grow.
So you could say profit is like a health checker for your business.
Imagine if you’re making lots of sales. You are busy and feel like you are doing well but what if your profit is poor ? There could be lots of reasons for this and sometimes it is intentional - you may be reinvesting profit actively whilst your grow to build a client base and your brand.
Or perhaps you are expecting your profit margins to be higher, and you may need to review your overhead costs to increase your profit.
Either way, it is just as important to keep an eye on your profit levels as it is your cashflow.
Gross profit versus net profit
Your gross profit is your total sales minus your direct costs. Direct costs are the costs of making your product or selling your service. These include the costs of your raw materials, transportation of those materials, and employees’ wages.
Your net profit is how much you’ve earned after you’ve subtracted your operating expenses from your gross profit, which include things like rent, insurance, etc.
Operating profit versus net profit?
Operating profit is your income after deducting operating expenses (such as rent, equipment, and employee payroll). It also takes into account things like taxes, interest, and profit or loss from investments.
Calculating operating profit is a useful exercise to help understand how efficient your business is operating before paying taxes. It helps you determine if your product or service pricing strategy is correct and how well you are managing your business costs.
How do I calculate profit?
The formulas for calculating profit are as follows:
Gross profit = sales - direct cost of sales
Net profit = sales - (direct cost of sales + operating expenses)
Operating profit = Gross profit minus operating expenses
Why calculate profit margin?
Your profit margin is calculated as a percentage that gives you an idea of how well your business is performing as per the various profit indicators above, but it useful to calculate as a percentage when comparing how you are performing against other businesses.
How do I calculate profit margin?
Gross profit margin = (gross profit/ sales) x 100
Net profit margin = (net profit/ sales) x 100
Operating profit margin (%) = Operating profit ÷ revenue x 100
Remember that it is useful to carry out this exercise to compare against competitors but it is more important to consider your own busies objectives, that may be different from your peers in the industry.
By doing the profit margin calculations and comparing against similar businesses, you also need to consider other that you may not be comparing like for like.
As well as profit margins to consider your business performance, you should also look at other metrics such as cash flow and business turnover or sales to get a full and accurate picture of how your business is performing.
How do I improve my profitability?
This very much depends on your unique business set-up but of course there are common ways to help increase profitability for businesses generally.
Consider the below:
Can you reduce your costs? – This is the first most common thing to look at. For example, can you negotiate with suppliers? Can you reduce your overhead costs like energy or bank charges?
Can you increase your sales? – This is another most common method to help increase your profitability by bringing in more sales or income into the business, perhaps by cross-selling to existing customers or targeting new customer segments without having to increase your existing costs.
How productive or efficient is your business? - Is there anything you can improve to produce products or deliver services faster so to increase time to sell to more people? Can you hire help to help you focus on business development and not do everything yourself?
