How to Calculate Gross and Net Profit Margin in Business
How do you work out percentage profit? Apart from non-profits, every business exists for the main purpose of making profits. This is achieved through the services and products it sells to buyers. Therefore, as it presents these services and products in exchange for money, it needs to know how it is faring as regards making a profit. A profit is only possible after an economic activity must have recovered or regained its production costs. How to calculate profit margin in business is a major requirement every business needs to know.
What is the formula for a profit?
How do you calculate profit? There are businesses whose owners have little knowledge on how to calculate a profit. These are especially rampant among small businesses. This article will provide an easy-to-follow step/guideline on how to calculate profit percentage in business as a measure to assist struggling businesses discover better ways of analyzing how well they are faring (profit-wise) and devising effective strategies for increasing patronage and sales, therefore positively impacting profits. So how do you calculate profit econ?
The Concept of Profits
For any business to realize profits, it must provide services or develop products which attract high sales. In order to maximize profits, close attention must be paid to the expenses incurred by the business in developing its products or services, and also the cost of the product stock. When producing such goods/products, it is done with the view of allowing an acceptable profit margin which allows the business make a profit while selling its products or services.
A requirement for understanding how to calculate net profit in business is to understand terms associated with profits. Gross profit earnings allow a business to know if it is making a profit or not.
- Gross Profits:
Gross profits are normally made by a business venture after it must have subtracted the cost of production of a product or service as well as that of selling them. In other words, it is the total amount of revenue realized by a business after it must have subtracted the cost of realising such revenue. Every economic activity has a cost, and as such, to realise the gross profit, the cost must be subtracted from the total revenue realised. A simple formula for calculating the gross profit is:
Sales – Cost of Goods Sold =Gross Profits
Fixed Costs as well as variable costs have a huge impact on gross profits. To understand how to calculate gross profit in business, it is necessary to properly understand these concepts.
- Fixed Cost:
As the name implies, this is a fixed, static or stable cost incurred by a business in the course of producing a good or service. Normally, fixed costs are made up of some of the following; marketing and advertising, employee benefits as well as taxes associated with the payment of wages, salaries and wages, insurance and rent among others. These are fixed costs a business incurs in the course of its operations.
- Variable Cost:
Variable costs on the other hand are costs a business incurs which are not static. They are normally running costs associated with the production of a product or service. These may include the cost of raw materials, purchase and maintenance of production machinery, packaging of products, transport/freight, direct labor cost as well as the wear and tear of machinery.
- The Gross Profit Margin
For a business to remain profitable, it must ensure that its gross profit margin is high or stable and does not decline. Sometimes businesses witness problems due to a declining profit margin. This may apply to businesses witnessing a high gross profit. An easy way of calculating the gross profit margin is by dividing the gross profit by the total revenue realised or generated by the business. This is represented by the formula:
Gross Profit/Sales = Gross Profit Margin
- The Net Profit
The net profit value simply means the profit after tax. This is also known as the net earnings or net income. This is represented by the formula:
Total Revenue – Total Expenses = Net Profit
The net profit margin on the other hand is calculated as a percentage requires the net profit figures and the total revenue. The net profit is then divided by the total revenue and multiplied by 100 as represented by the formula below:
- Net Profit/Total Revenue x 100 = Net Profit Margin
In wrapping up how to calculate profit in small business, you have to know that gross profit is made up of net profit, variable cost, as well as fixed cost or expenses. Thus, it can be represented by the formula:
Sales/Discounts + Cost of Goods or Services + Gross Profits
Wrapping Things Up
Expenses have a huge impact on any business venture. Therefore, it is normally advisable that a business tries to significantly reduce its expenses through a review process to ensure that only the basic or essential expenses are made. Therefore, for any business entity which wants to increase its sales or profitability, this should be a major decision to make.
Every business venture seeks to achieve profitability, and the process of calculating these profits have been provided here. As seen above, how to calculate profit in business requires several variables, and these must be clearly known by following a systematic process as given above to arrive at the exact figures. The outcome will always reveal if the business is making profits or not.