All small businesses need to know how to calculate profit so they can work out how well they’re performing.
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While you may have started your business out of a passion for your niche, all small business owners need to make a profit to be successful.
But there are different terms to understand before you can calculate profit. Get started with this quick guide.
Why should you calculate profit?
Profit is one of the main indicators of business performance. With lots of money flowing in and out of your business it’s not always clear how much money you’re making. By calculating profit over a set period of time, you can keep an eye on your business’s health.
Imagine if you’re making lots of sales. You think you’re doing well but you’re actually struggling financially. When you work out your profit you see that you’re not being left with as much money as you’d like.
That might then lead you to look at improvements in other areas, like cutting transportation costs, making it more efficient.
It’s also useful to calculate profit if you have your eye on expanding your business. The healthier your profit, the more opportunity you should have to invest in growth.
The difference between gross profit and net profit
Before we show you how to calculate profit it’s important to understand the difference between net profit and gross profit. That’s because if you calculate one but think you’re calculating the other, you’ll get into trouble with your figures and won’t have an accurate picture of how your business is performing. Here’s the difference:
gross 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
net profit – this is how much you’ve earned after you’ve subtracted your operating expenses from your profit, which include rent and business insurance (and sometimes your taxes too)
Is there a formula to calculate profit?
Use the calculations below to work out both your gross profit and your net profit:
Gross profit = sales - direct cost of sales
Net profit = sales - (direct cost of sales + operating expenses)
How to calculate profit margin
Your profit margin is represented as a percentage rather than a figure in pounds. The profit margin essentially tells you the same thing as the calculations above, but the percentage is useful when comparing your performance to other businesses.
You can use these calculations to work out your gross profit margin and your net profit margin as a percentage:
Gross profit margin = (gross profit/ sales) x 100
Net profit margin = (net profit/ sales) x 100
Keep in mind that there isn’t necessarily a ‘good’ profit margin you should be aiming for. It depends on what your overall business objectives are.
Plus different businesses have different propositions which means comparing can be quite limiting. When setting profit goals, it’s good to look at similar businesses to yours.
You also need to consider your profit margin alongside other metrics like your cash flow and business turnover to get a full and accurate picture of your performance.
How to improve your profit margin
There are a number of ways to increase your profitability. The route you go down will depend on the specifics of your business but you could look at:
reducing costs – many businesses choose to use this method. Are you on the best deals possible with the utility companies and your bank? When was the last time you negotiated rates with your suppliers?
increasing turnover – one of the ways you can do this is by focusing on your existing customers and up-selling or cross-selling goods and services
increasing productivity – are there any processes you know you can improve? Maybe using time and project management tools will boost your own (and your employees’) productivity, letting you get more done in a shorter space of time
Read more about how to increase profit. Analysing your profit margin and drilling into other metrics should help you find more ways to improve.