Calculate Profit in Companies

To find out if a company is in good health, it is necessary to look at a key indicator: profit in companies. As the students of the MBA in Asturias know. Knowing how to calculate this value is essential to designing any future business strategy with minimum guarantees. However, the concept of profit in the company is comprehensive since it covers different metrics.

This article will focus on knowing what profit in companies is and how to calculate it reliably for proper business development.

What are gross and net Profit in Companies, and how do you calculate them?

The concept of benefit refers to the difference between the total income gained from a sale and the costs of producing the product or service. The benefit is, in short, what the company will earn once it has sold its products or services and has paid all the costs of the possessions used.

Within the concept of profit, we can distinguish between gross profit and net profit in finance. Both metrics, also well-known as gross margin and net margin, are linked to each other, but there are different nuances.

Gross profit

Gross profit is the total income (sales) less the cost of expenses directly related to producing the products or services.

Among the variable costs that participate in the sale and vary according to the production or commercial level, equipment, raw materials, external suppliers, packaging or direct labour, among others, can be considered.

Going a little deeper, the gross profit is the value that is extracted after subtracting the variable costs of a business (those that fluctuate depending on the volume of sales and production, they do not exist if there is no production) to the income generated before deducting taxes, personnel expenses, relevant depreciation and other costs during a given period.

Thanks to the calculation of gross profit, it is possible to evaluate the efficiency of an organization in the use of its labour and its supplies to produce the goods or services that it offers to the market during a specific time.

Imagine that a company enters 20,000 euros in sales and the total cost of goods sold is 8,000 euros; the gross profit would be 12,000 euros. Instead, your competition generated $20,000 in sales, but the sold goods cost was $5,000. This implies that the match is making more efficient use of money.

Net profit

Once the gross benefit has been calculated, the value of the net benefit must be obtained. Which represents the resulting profit after paying the expenses. That is, how much money remains at the end of a specific period.

To find this index, it is necessary to detail the company’s fixed costs, those that do not vary, such as real estate rental, office expenses, workers’ salaries, or some taxes. To calculate the net profit, the following formula will be applied:

Net Profit = Gross Profit – Fixed Costs (Taxes, Interest, Depreciation, General Expenses)

Let’s see an example of this formula for which we must first calculate the gross profit. A company enters 350,000 euros, and the cost of the production expenses of the goods sold amounts to 50,000 euros. These figures show a gross profit of 300,000 euros.

We subtract the fixed costs from the gross profit (70,000 euros corresponding to salaries, 20,000 euros of operating expenses and 5,000 euros of taxes). The result is a net profit of 205,000 euros.

Net profit also known as the Result of the exercise in the income statement. An organization must find out how much money it is generating during a period and the level of profitability. Moreover, its financial stability.

The income statement and its indicators to measure profit in companies

The profit in companies and loss account or income statement is the tool to measure the accounting profit or losses during a given period in the company. One of the leading financial statements is the balance sheet (which indicates the economic situation, everything the company owns) and the cash flow statement (which collects cash inflows and outflows).

The profit and loss account offers the results derived from the company’s management during the ordinary operations of income and expenses.

Based on income, the income statement informs us of how these are transformed into profit as expenses are subtracted. The profit and loss account result can be a profit when income exceeds expenses or a failure if costs exceed revenue.

The income statement presents schematically in cascade form and is calculated as follows :

Income (Sales or service provision)

– Cost of sales (variable costs)

= Gross Margin

– Fixed expenses (Salaries, supplies, advertising, insurance, leases,…)

= Operating Income (EBITDA)

– Amortization expenses

= Earnings before interest and taxes (EBIT*) or (BAII)

+ Financial income

– Financial expenses

= Earnings Before Taxes (EBT*)

– Corporation tax

= Net profit or Result for the year

1. Operating income

The operating Result (operating Result) or EBITDA ( Earnings before interest, taxes, depreciation, amortization ) shows the operating Result before subtracting amortizations, among which are the financial operations of the company or taxes on benefits.

Depreciation and amortization refer to those investments that lose value over time. The first affects tangible fixed assets such as equipment, furniture or vehicles that depreciate over time, while amortization includes intangible assets such as legal rights or patents.

This indicator makes it possible to measure a company’s operating performance by analyzing profits without taking into account variables such as taxes or interest. For this reason, investors tend to pay close attention to this metric as it allows them to buy companies with greater objectivity.

To calculate EBITDA , the following formula can apply:

EBITDA = net profit in companies+ interest + taxes + depreciation + amortization.

2. Financial result

This is the summary of those expenses and income that do not come from the main activity, such as financial assets or credit costs. Payments can represent by commissions on loans or credits, while income would be interest favouring the company from current or savings accounts.

3. Results before taxes

Two indicators stand out:

One of them is the EBIT ( Earnings before interest and taxes). BAII (Profit before interest and taxes) is the profit without discounting interest and taxes. Two formulas can apply to calculate EBIT :

Formula 1 EBIT = Net Earnings + Interest + Taxes

Formula 2 EBIT = Sales revenue – gross margin – fixed expenses.

The use of this profitability metric is to provide a more accurate understanding of the performance of operations. Even without taking into account their debt obligations. Therefore, we can also refer to EBIT as operating profit or income.

By focusing on operating profit, it is possible to analyze its operations more clearly and see the growth potential.

Another indicator is the EBT ( Earnings before taxes ), which includes the financial impact. Its equivalent acronym in Spanish is BAI (Profits before taxes) and allows evaluating a company’s profitability without the effect of its tax regime. It results from the sum of operating expenses plus financial expenses and income.

4. Income for the year or net income

The net Result or Result for the year is the difference between income and expenses, including taxes, for a given time. Generally a month, a quarter or a year. It forms the last line of the income statement and represents how much money a company has after paying all expenses.

As we have seen, it is one of the most used metrics in finance to measure the organization’s success. But it is essential to keep in mind that the net result changes depending on industry in which it is located.

An income statement is a vital tool for analyzing the company and quantifying profits or losses throughout a specific year. In addition, it allows for detecting the causes of the Result, that is, why money is being earned or lost. Keep in mind that the profit and loss account shows results from an economic point of view, but not financial.

The income statement reflects a reliable and accurate picture of the company’s state, showing whether it can operate productively. It is, in short, financial proof that the company is profitable. In the event of a negative result. Also it is necessary to analyze the reason for the loss and design the appropriate strategies to correct it.

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