Best Ways to Calculate Your Profit
If you’re starting a business, you’re going to need to know how much money you’re really making! Often, entrepreneurs are great at what they do, but they’re not so great at the financial side of things. Not to fear! This article will tell you what you need to know about calculating your profit and more.
Revenue vs. Profit
Revenue is all the money that your business brings in from doing business. In other words, it’s the amount of your sales. It does not include money that you put into the business, or money that the business receives from lenders or investors.
It would be great if you could keep all the money you bring in, right? But, alas, you have expenses. You have the costs to make your product or provide your service, and you may have monthly expenses that you pay for your business location rent, utilities, insurance, software expenses, marketing expenses, and more.
Profit is what’s left of revenue after you pay all those expenses. In simple terms revenue minus expenses equals profit.
Gross Profit vs. Net Profit
To complicate things, you’ll have gross profit and net profit. Gross profit, also known as gross income, is what you make after your cost of goods sold. So, if your product costs $10 to make or purchase at a wholesale price, $10 is your cost of goods sold. If you sell your product for $30, you’ll take your revenue ($30) minus your cost of goods sold ($10) to get your gross profit.
On your income statement, it will show your total revenue minus your total costs of goods sold to give you your total gross profit. For example, using the scenario above, if you sold 100 products in a month, your revenue is $30 x100, or $3,000. Your total cost of goods sold is $10 x 100, or $1,000. Your gross profit is, therefore, $2,000.
To calculate your net profit, you have to deduct the rest of your business expenses. Gross profit minus your monthly expenses equals your net profit. So, if your monthly expenses were $500, your net profit is your gross profit ($2,000) minus your monthly expenses ($500), or $1,500. That is the amount you keep in your pocket for the month – your net profit.
Profit Margin
Your profit margin is simply your profit expressed as a percentage. Again, you’ll have a gross profit margin and a net profit margin. Your gross profit margin is the percentage of revenue that remains after your cost of goods sold, which is your gross profit. You’ll take your gross profit ($2,000) divided by your revenue ($3,000) to get your gross profit margin, which is .667, or 66.7%.
Your net profit margin is the percentage of revenue that remains after all your expenses, which include your cost of goods sold and your monthly expenses. That remaining revenue is your net profit, which is $1,500. So to get your net profit margin, you’ll take your net profit ($1,500) divided by your revenue ($3,000) to get your net profit margin, which is .50 or 50%.
Calculating Your Markup
So, why does all this matter? You can use these numbers to determine what your markup from your cost of goods sold should be based on how much money you want to make. Of course, you still have to price your products to be competitive in the market but using the information will give you some guidance when it comes to pricing for profit.
So, say you know that you need to have a gross profit margin of 80% to make enough money to pay your monthly expenses and pay yourself. If your product, again, costs $10 to make, how much does your price need to be to get you an 80% gross profit margin?
It gets a little sticky here because you have to look at the equation a little differently. To get to an 80% gross profit, your cost of goods sold needs to be 20% of your price. Therefore, to calculate the price that you need to achieve that 80% mark, you’ll take your cost of goods sold ($10) divided by 20% or .20, and that will give you a target price of $50. That means that to achieve an 80% gross profit margin, you need to raise your price from $30 to $50.
(Instead of going through this math, you can use an online markup calculator.)
Again, you may or may not be able to raise your price, based on what price the market is willing to pay for your product. You could instead try to reduce the cost of goods sold to increase your profit margin. If you are purchasing your product wholesale from a manufacturer, usually if you increase the amount you purchase from them at one time, they will offer a discounted price.
If you can get your cost of goods down to $8, you only have to raise your price to $40. To get to your target profit margin of 80% without raising your price, you’d have to get your cost of goods down to $6.
Projecting Your Profit
You can also use your profit margins to project how much you’re going to make each month or for the year based on what you think your sales will be. If all things stay the same in terms of cost and price, you know that your gross profit margin is 66.7%.
If you increase your sales to 200 products for the month, your revenue will now be $6,000. Your gross profit is therefore about $4,000. If your monthly expenses stay at $500, your net profit will be $3,500. What this means also is that you’ve increased your net profit margin to about 58%.
If your monthly expenses stay constant, as you increase your sales over time, your net profit margin will continue to increase. That means more and more money stays in your pocket!
In Closing
As a business owner, it’s important to understand your financials at least on a basic level, even though you may not enjoy it. However, there are many online tools that can help you, and at some point, you’ll probably want an accountant to help you with financial statements and taxes. Now, though, you know the basics of calculating your profit, so go ahead and get back to work and make that profit grow!
