Business is all about making a profit, isn’t it? But in accounting, there are several terms used to express different kinds of profit. Ultimately, what should interest you is your operating profit.
There are multiple names for operating profit. You might hear people refer to it as EBIT which is the acronym for earnings before interest and tax. It can also be called PBIT which stands for profit before interest and tax. Another name for it is net profit.
Operating profit is the profit you make after you’ve deducted your costs for making the goods you sell and also the costs for running your business. Furthermore, it’s your total revenue minus costs of sales along with operating costs.
How to calculate operating profit
The easiest way to show you how to calculate your operating profit is to use an example. That way you can translate it to your business and make your own calculations.
Let’s take an artist as our example. Say you’re an independent artist who sells their art and you’ve got your own company. The moment you sell a piece, you’ve made revenue. As per our definition of operating profit, you now need to deduct the costs for creating that artwork. This will comprise the money you spent on your paint and brushes, your canvas, etc. The amount you get is your gross profit.
Gross profit will have to be reduced by your operating costs so that you get your operating profit. If you’re a self-employed artist, your operating costs would be the salary you pay yourself, paying any freelancers you’ve hired for various purposes (social media mangers, for instance), marketing expenses, studio rent, etc.
Operating profit example
When we apply real numbers it will look something like this:
|Price in £||Explanation|
|REVENUE||250||The price of the artwork sold|
|COST OF SOLD GOODS||-50||Costs for buying paint and brushes, canvas, etc|
|OPERATING COSTS||-150||Costs for salaries, hiring freelancers, rent, marketing expenses, etc|
You can look at operating profit per unit sold as we did in our example above. Or you can also calculate it on a monthly or yearly basis. The principle stays the same, but the numbers are going to be larger as you’d be working with your total revenue, total costs of sold goods, and total operating costs.
It is not uncommon to express operating profit in percentages. When doing so, it is normally referred to as profit margin. It really is a matter of preference. Should we want to do that with the example we used, we’d have to see what percent £50 is out of £250. A simple math calculation [(50 / 250) x 100] will lead us to 20%.
Why calculate operating profit
Fundamentally, it’s the indicator of your company’s financial performance and success. It will show you if your business is on solid ground. From a managerial point of view, it will indicate whether you should be considering reducing some of your costs in order to increase your profit margin. Or whether you need to adjust your prices so that you stay profitable.
In conclusion, it’s certain that you should constantly be monitoring your cash and tracking performance. So, download our FREE cash flow guide to start taking control of your finances. Or you can sign up for a FREE trial to Numbers Know How and gain access to a Cloud planning tool, tips, techniques and resources.
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