Profit should be one of your main business goals. Profit is used to build sustainability, monitor, manage, and measure your performance. But what is profit in business, and why is it so important?
For most people, profit is the difference between money in and money out. When people say money, they mean notes and coins, what’s in their bank account. That sounds straightforward and sensible, nice and easy to calculate.
However, we are talking about the world of numbers and business here! It’s time to burst the bubble.
Profit is not measured in terms of money in and money out. When you calculate profit it’s a completely different ball game.
Accounting jargon explained
Firstly, before we answer what profit in business is, you need get familiar with some accounting jargon. Don’t worry – I have my jargon converter at the ready!
Turnover. When your business provides your promise, and your customer becomes responsible for paying for that promise you have turnover. Your promise BTW is the products and services you sell. So, turnover is the financial value of the products and services you have provided to your customer. Revenue is recorded when the sales event occurs, e.g. products delivered or services carried out.
Cost of sales. These are the costs that are easily traceable to the products or services that you sell. For example, if you make furniture then the cost of wood, workers’ wages is a cost of sale. If you run a restaurant, then the cost of ingredients and chefs’ wages are your cost of sales.
We’ll get to profit in business very soon. Two more terms to explain before we dive in.
Expenses. Your business will have support, admin, and infrastructure costs. For example, your restaurant will have front-of-house staff, costs of printing menus, repairs, advertising, and accounting staff. If you hear terms like overheads, running costs, operating costs then fear not, these are expenses under another name.
Incurred. Costs and expenses are recorded when you have a liability and responsibility to pay the supplier. For example, in situations like when your supplier carries out the service for you. When your staff work, you incur a cost. The same happens when you print your menus – even if the money doesn’t leave your bank until well after the event.
Profit in business
Well, there are two main profits in your business, gross profit and net profit.
For an accurate calculation of profit (and accurate and accounting don’t always go together) here is what to do.
We apply a key accounting rule known as the ‘matching principle’. Compare the costs of producing, servicing and providing for the goods and services actually sold.
- Gross profit/margin
- Turnover less cost of sales
- Net profit
- Gross profit less expenses
Operating profit is also known as:
- EBIT – earnings before interest and tax
- PBIT – profit before interest and tax
- Net profit
Profit doesn’t mean your business will survive
A profitable business does not mean you have money in the bank. It is not unusual for your business to be profitable but up shit creek without a paddle. Profit and debt can go hand in hand.
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