The profit gained by a company in comparison to the total revenue generated by it is called profit margin. This metric is expressed in percentage. When you sell a product at a price higher than its cost price, you gain a profit. The overall profit and the performance of a business can be assessed by calculating the profit margin and profit percentage. These figures help to evaluate the business’ financial stability and potential for growth. A high profit margin should be maintained to achieve financial success.
Any business person needs to understand the different types of profit calculation and their formula. This knowledge will help you calculate profit and assess the performance of your business.
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What is Profit and its Different Types?
When the revenue generated by a business surpasses its overall investment cost and taxes, it is said to have earned profit. Profit is divided into different categories. Each of these is calculated using different formulas. It is important to learn how to calculate the profit percentage for each of these.
Types of Profit and How to Calculate them:
Gross Profit
Gross profit refers to the total revenue an organisation churns after subtracting the expense involved in manufacturing, marketing and selling its products. The same holds true for companies operating in the service industry. The amount involved in providing the service is deducted from the total revenue generated by selling the services to derive the gross profit. In short, subtract the cost of goods sold (COGS) from the revenue generated to get gross profit.
Also known as gross income or sales profit, it is reflected on the income statement of an organisation.
Net Profit
Net profit refers to the total income generated by a business after subtracting the cost of goods sold, depreciation, amortisation, interest, taxes and expenses. Also referred to as net income or sales profit, it is the amount left after deducting the revenue generated from the expenses and losses a business incurred during a period. The figures derived reflect a company’s financial standing after all its expenses have been paid. Business owners can create effective financial strategies by looking at the net profit earned by them. It also helps them calculate the tax that needs to be paid. On the other hand, creditors can take a look at the net profit of a business to assess its ability to repay a debt.
Operating Profit
Operating profit is the total earnings from an organisation’s core functions minus interest and taxes levied on it. Any profit generated from any other businesses that it is a part of is not included in this calculation. Operating profit is often confused with EBIT (Earnings before Interest and Tax). It needs to be understood that the two are different from each other as EBIT may include non-operating profit. Whereas, any non-operating income is not a part of a company’s operating profit.
Operating profit is said to show an accurate picture of a business’s performance. This is because it is devoid of all the extraneous factors and takes into account all the expenses a company bears to operate its business. A firm is said to have incurred operating loss when the total income generated by its core business is less than its overall expenses. Businesses have the option to present their operating profit figure instead of net profit figures. Many business owners choose to do so if they have a high debt load. This is because the operating profit is likely to show a company’s financial performance in a better light in comparison to net profit.
How Can You Calculate Your Business Profit?
It is important to learn the procedure to calculate your business profit in order to derive accurate figures. The profit formula helps understand the gain made in a given transaction. Different types of profits shared above call for different types of calculations and thus their formulas are different from each other. Given below is the basic formula for computing profit:
Profit = Selling Price (S.P.) – Cost Price (C.P.)
Here, the Selling Price is the price at which a product is sold. Cost Price, on the other hand, is the price at which the product was bought by the seller or the total expense involved in manufacturing it.
Different Formula for Calculating Profit
Let us now understand how to calculate the profit percentage of different types of profit including gross profit, operating profit and net profit. We have also shared how to calculate profit margin percentages. Calculating profit margins is important to compare the profit of your business with that of different organisations in your industry. Investors seek this information to determine which companies are churning more profit so that they can make their investments wisely.
1. Profit Percentage Formula
As the name suggests, profit percentage is the amount of profit earned expressed in percentage. Here is how to calculate profit percentage:
Profit = Selling Price – Cost Price
Profit Percentage = Profit/ Cost Price * 100
2. Gross Profit Formula
Gross Profit = Total Revenue – Cost of Goods Sold
3. Net Profit Formula
Net Profit = Total Revenue – Total Cost – Indirect Costs
4. Operating Profit Formula
Operating Profit = Gross Profit – (Operating Expenses – Day-to-Day expenses such as depreciation and amortisation)
5. Operating Margin Profit Formula
Operating Profit Margin = (Operating Profit/ Total Revenue)*100
6. Profit Margin Formula
Profit Margin = (Profit/ Total Revenue)*100
7. Gross Profit Margin Formula
Gross Profit Margin = (Gross Profit/ Total Revenue)* 100
8. Net Profit Margin Formula
Net Profit Margin = (Net Profit/ Total Revenue)*100
9. Average Profit Formula
Average Profit = Total profits/ Number of years of profit
Conclusion
We are sure, by now you have understood how to calculate margin as well as profit percentage. Different types of profit including net profit, gross profit and operating profit need to be calculated to assess a company’s financial health. This calculation is important for business owners as it helps them understand the rate at which they are growing and further potential for growth. The figures also hold importance for investors, shareholders and creditors as they help them make an informed decision about making an investment or lending money.
What is best for you completely depends on your current situation and future business plans. For some of you, the best bet would be to reinvest the profit in your business with the aim to grow. Others may want to distribute the profit among shareholders as dividends to strengthen their business relations and gain from it. Yet others may like to save the amount for personal use.
Profit margin is calculated to assess an organisation’s performance during a given period. It is a numerical expression of a business’s financial performance and operational efficiency. It helps in determining whether a business’s profitability is increasing, decreasing or constant. By assessing this, the business owners can make informed business decisions.
The profit margin ratio determines the percentage of net income in a company’s sales. It helps to know the profit generated from a company’s sales.
