One of the good financial practices regarding financial matters is calculating profit margin. Understanding profit margins and profit is very important for the decision makers in any corporate sectors and for business owners. Companies should achieve success and flourish to earn enough money.
Profit is the total sum of money earned by any company, small or large against the capital it has spent on running a business successfully. Determining profit is one of the measuring factors about how any company is performing. If the margin of profit shows a rising trend, it indicates that the management team is working fairly well in making decisions; the company is working in a right way whether it is selling services or products and has a strong vision towards the future.
Revenues and profits are not the same, though it’s similar with regard to that both compute cash coming into an organization or company.
What are profit and revenue?
Profit is a kind of financial assessment used to estimate the performance of a company. It is the sum of money left over after all the business expenses have taken into account over a certain time period. Revenue shows the total income approaches a company or the total sum of cash used for making a business run.
But revenue does not show the amount of profit a company is making. So it cannot be an accurate benchmark for assessing financial performance.
To get hold of about how a company is performing and its course of action, calculating the gross profit is very much crucial. It helps in understanding the current profit situation in any business based on two factors namely: cost of sold goods and net sales. The net revenue earned by any company before subtracting the expenses occurred in running that business is called the gross profit.
Decision makers of any business should know about these basic profit types-
- Operating profit-
It is one of the key categories in the income statement of a company. It is the leftover cash remaining after all the expenses have been deducted in operating a company from the gross profit of the business. Normally expenses emanate from administrative, sales and generally related expenses.
- Gross Profit-
It is a section in the income statement of a company that calculates the sum of total revenue deducted from the price of services or goods traded by any business. In terms of accounting language, gross profit is the total profit incurred by a business before operating out interest payments, taxes and expenses that are included.
- Economic Cost-
Economic profit is the opportunity cost in contrast with total revenue collected in running a business. Companies often go for different strategies with optimum possible outcomes. In this context economic profit is the sum of money earned by a business after selecting one business plan over another, the company may have selected-but didn’t.
Gross profit, Net Sales and Gross Profit Margin
We can calculate the gross profit by subtracting the costs of goods sold from Net Sales. If Net sales are not known we can calculate Net Sales by subtracting (Allowances and Returns + sales discounts) from Gross Sales. Cost of sold goods is the base value of the goods sold and does not consider the overhead costs like interest payments and payroll taxation.
Gross profit represents a broad image of income statement in multi-step before deducting the costs of the factors associated in it like, administrative and general expenses, selling, non-operative revenues, non-operative expenses, losses and gains.
To calculate the gross profit anyone must know the total sum of variable and fixed costs associated in that business. Variable costs are the costs associated with making the product which includes direct labour, materials used, packaging, depreciation and freight. Fixed costs are constant in nature which mainly includes salaries, office expenses, wages, rent, advertising and insurance.
To figure out if the business is running successfully or not it is significant to know the Gross Profit Margin.
From this, anyone can also evaluate the present state of a company compared to past performances, where fluctuations in goods prices are significant. The greater is the percentage of gross profit more prosperous is the business and anyone can expect more profit out of it. The margin of gross profit gives an idea of profitability trends.
The business may show a downward spiral if the gross margin shows a rising trend and gross profit margin declining. To raise the rate of gross margin prices of goods and services should be increased and reduce the costs.
Understanding the graph of Gross Profit indicates how productive business is with respect to the production of services and goods and will give an idea of the scope of earning available. On the other side, the gross profit margin will show the percentage of income gained from selling services or goods. Finally, Gross Profit is important for understanding the profitability, efficiency and success rate of any business.
Net profit margin is the total profitability of a company on all services and products of it. It is also expressed in percentage. A strong net profit margin implies that the company is free of errors and legitimate and is growing steadily over a period of time. a weak net profit margin indicates problems which include, poor demand for services and goods, weak management decisions, poor revenues, weak sales and high costs.
Calculation of net margin of a company includes all costs and revenues of a company.
Gross margin can be increased for profitable and sustainable growth by decreasing variable costs, increasing prices of products or product Mark up.
With accounting software calculating gross margin and gross profit becomes fairly easy and straightforward metrics. Accounting software, fortunately, produces these reports quickly and accurately and it’s feasible to share within clients.
Businesses depend on the terms revenue and profit synonymously but in an organization, they are different concepts. While revenue is money generated through the sales of products or service, profit is the amount that will remain when the costs are derived post the subtraction of all the costs. For any organization, the ultimate objective is creating revenue but to remain workable, businesses need profit.
While understanding the principle of business, economics, accounting and business analytics, it is important to understand the difference between sales revenue and profit. While determining the overall health and stability of any small, medium or large business enterprise, both profits and sales revenue are essential to be examined.
Fundamentals of Sales Revenue, Revenue and Profit
Sales Revenue is a very crucial term in businesses that implies the total income a business generates by selling its goods and services. Sales revenue is fundamentally the billings and receipts from the sale of goods or services and removing the returns and allowances from gross sales revenue. Sales revenue and revenue are terms that are used interchangeably but all revenue does not come from sales of products or services. Total revenues on the other hand also include other sources of income like interest that is earned on credit sales.
Profit generated for any business is its total revenue minus the total cost and it is a bottom line or any business, bog or small. Profit, more specifically, is the amount of income which will remain after we subtract all taxes, expenses and costs. Sales revenue considers the only amount of income that any business generates after the sales of its goods or services. The key concept is that profit considers income as well as expenses. Profit is generally broken down into gross profit, operating profit and net profit which is what remains from the income after the expenses are paid.
Why Sales Revenue and Profit Matter?
Many medium and large businesses depend on their investors and the investors care about profit and sales revenue as they provide insights into a business’s health. While profits help a business understand how much value is captured through price and cost of their goods, sales revenue help understand the quantity demanded at any price. Profits, as well as sales revenue, are important factors while considering the profitability of a business.
Formula to Calculate Profit
Formula to solve profit is as below:
Profit (p) = revenue (r) – costs (c)
While calculating profit, the difficult part is organizing revenue, organizing costs and assessing the profit. This is done by the accountants who prepare a company’s income statement. The first thing on an income statement is Revenue. Then the costs of goods sold are removed which gives the gross profit. After this, the fixed costs are removed which gives operating profit. The net profit is determined by adding irregular revenue and removing irregular expenses.
While calculating sales revenue, the selling price of each of the good and service is multiplied into the total number of goods or services that are sold. While calculating profit, the total costs are subtracted from total revenues.
Let’s See an Example
One of the simplest calculations is Gross Profit which is a simple formula of revenue minus the costs of goods sold. An example of this can be, if any business has revenue of 10000 in a fixed period and COGS is 3,000 then the business’s gross profit is 7,000. Alternatively, an inverse formula is also used to arrive at revenue when both the profit as well as the costs is available. Revenue is simply profit plus costs. Thus, 4,000 in gross profit and 6,000 in cost of goods sold give 10,000 in revenue for the period.
Wide use of profit margins is used substantially in corporate finance field when dealing with financial ratios. When it comes to calculating profit of an organization, three aspects matter. It starts with gross income, then move onto operating profit and lastly net profit. Have a look at these in detail below.
Gross Profit
It is a profit that an organization earns after deducting a product’s manufacturing and selling cost. It appears on a firm’s income statement and is calculated by simply subtracting cost of items sold from sales. Such figures are recorded in any institute’s income statement. It is also known as gross income or sales profit.
Gross incomes helps in assessing an organization’s efficiency when it comes to using supplies and labor for production of commodities and services. Variable costs is what this metric considers which is costs or amount that fluctuate with output level like direct labor, materials, fees for credit cards, shipping, equipment, etc. This is what sales profit informs the management of a company.
Operating Profit in detail
This profit refers to an accounting numbers which measures a sum of profit earned by an organization from its core ongoing business operation. Also, it excludes tax and interest deductions. However, the value one gets after all this deductions still doesn’t include any gain that a firm’s investment earns like earning from a company in which an organization has a partial interest.
It is sometimes called operating income or earning before tax and interest. However, the latter sometimes include revenue which is non-operating and not operating profit’s part. If any company doesn’t have this revenue, then earnings before tax and interest will be equivalent to operating profit.
Author Bio-
Nancie L Beckett has an MBA Degree Haas School of Business with 6 years of experience. She has excellent skills and an expert in various fields. One of the efficient online academic tutors, she provides all the necessary guidance to students and help them in gaining the best possible results. Contact her in case you required assistance.