Profit calculation is a key practice in measuring the success of any business. It allows you to evaluate the overall costs of your operation and understand what return on investment can be expected.
In this guide, I will overview the most common terms and profit formulas, provide examples of where they might be applied, and discuss the tools that can help you track these numbers.
Before we dive deeper, here are the main formulas used for profit calculation.
Profit Calculation Formulas
| Profit Formulas |
|---|
| Profit = Revenue – Costs |
| Profit Margin = (Revenue – Costs) / Revenue * 100 |
| Gross Profit = Revenue – Cost of Goods |
| Operating Profit = Revenue – Cost of Goods – Operating Expenses |
| Net Profit = Revenue – Cost of Goods – Operating Expenses – Tax |
What is Profit Calculation?
Profit calculation is a practice used better to understand the profitability and success of your business. It evaluates the total business earnings versus various direct and indirect costs accumulated to achieve the result.
In its most basic form, Profit is calculated by subtracting business costs from revenue.
This way, you can quickly measure what is left of the revenue after accounting for all the expenses. In case, you are left with a negative number after this calculation, it means your business is at a loss instead of profit.
Since this calculation is made in actual sums, it can be hard to evaluate how has the company improved over a period of time. To get a better sense of that, most businesses use a modified version of this metric which is the Profit Margin.
Profit Margin
The Profit Margin represents the percentage of income remaining after the costs have been subtracted.
By using this metric, it becomes much easier to measure the performance of the business and compare it quarter to quarter or year to year.
For example, imagine you have a growing business, and your revenue has increased substantially over the last quarter. However, you have also been investing heavily in new tools, employees, etc. In such a case, you may see an increase in profit, which is great. At the same time, you should see what was the effect of these efforts on the profit margin. Has it stayed the same, reduced, or maybe improved? Thus allowing you to better understand if the additional investment allowed you to operate at the same, increased, or decreased profitability.
Gross Profit
Since there are quite a few factors to be evaluated with profit calculations, they are further divided into Gross, Operational, and Net Profit. Each of these varies in the costs that have been subtracted from the revenue thus giving us additional insights into the business operation.
Gross Profit shows the difference between your revenue and costs of goods.
Measuring this number allows you to see firstly, if the goods you are selling cost less than what you are making for them. You can also calculate the Gross Profit Margin by adapting the formula above.
Operational Profit
The next level of profit calculation to be evaluated is the operational profit. Allowing us to understand the profit or loss after evaluating the operational costs as well as the cost of goods sold.
Operational Profit showcases the business revenue after the cost of goods sold and the operational expenses.
This metric allows us to delve into the deeper analysis of how much profit the business is left with after the costs of running the operation. This metric is usually affected when the company hires more staff, upgrades the tooling, etc.
Net Profit
Net Profit is the final step in the profit calculation process. It looks into how much revenue the company is left with after all the direct and indirect expenses they endured.
Net Profit is the profit generated after subtracting all the expenses and other costs of the business.
This is the bottom line of what the company managed to make at the end of the day. Such a measure is important to understand the full picture and see what money can be invested forward or used in other ways.
Tools for Profit Calculation
Now that we have overviewed the main terms and formulas used in the practice of profit calculation, let’s touch upon how such calculations are usually made.
The difference between the tools used to calculate profit usually lies in the goal of where it will be applied. So let’s look at a few of the most common cases.
End of quarter/year reports
There is no doubt you will have to look at the business profit calculations to evaluate the success of your efforts on a yearly and quarterly basis. In such cases, you will most likely enlist the help of your in-house accounting team or accounting system that will provide you will the overall numbers and reports for the specific period of time.
This way you can evaluate the performance of the company and direct further initiatives as well as investments.
End of project profitability calculation
For those working and evaluating their progress on a project-to-project basis, end-of-year reports may not be as important as tracking the profitability of each separate project. In such cases, most of the information is tracked and can be easily evaluated by using project or task management tools.
Here, you can enter the overall budget allocated to the project, plan out the required steps, and allocate budget portions or hourly expenditures for each of them. As the project begins, your team will track the time spent on each task and then you can automatically calculate the actual costs that occur.
For this, you will need one additional metric – hourly rates for your team. Which then multiplied by tracked time will provide you with the overall or currently spent budget.
Tracking the operational profit margin for a project
In case you are leading a project, you may need to track the operational profit margin. This would allow you to understand whether more resources can be added and if you are on track with your budget.
In this situation, there is quite a case to be made for project management software. With such solutions, you already have all of the project information, such as budgets, deadlines, resources, and hourly costs in one place. As the project begins, you can also track time spent on tasks and record other expenses.
With all of this, you can build custom formulas that will automatically calculate the operational profit margin for you. The beauty of this is – all of the required data is already stored in your tool, you just need to apply it. Here is an example of such an automated calculation in Teamhood.
Tracking the gross profit margin to determine sales prices
Another case where you might need to use gross profit calculation is for sales or other teams that determine product pricing or discounts that could be applied to clients.
Once again, using a task management system, such teams can create custom calculations that will track their gross profit margin based on the entered data. Furthermore, you can automate the calculations for the cost of goods sold by basing them on the quantity purchased by the client.
Here is an example of such automation in Teamhood, where based on the quantity, different COGS values are automatically applied and then used to calculate the gross profit margin.
Final thoughts
Profit calculation is an important business process that should not be taken lightly. It helps us make important decisions and steer the business operation in the right direction. With the help of modern tooling, it is easy to automate these calculations and gain immediate insights for various teams and processes. Allowing you to track and understand the state of your business without having to wait for the end-of-the-year reports anymore.
