How do you calculate total profit like a pro—and use that information to grow your business?
How to calculate total profit boils down to a simple formula. But before you apply that formula to your business’ financials, it’s important to understand the different factors that play into profitability—and how to use them to determine the total profit your business is bringing in.
So how, exactly, do you do that? Let’s take a deep dive into how to calculate total profit like a pro—and use that information to take your business to the next level:
What is total profit?
At first glance, profit seems like a simple concept. But spend a few minutes reviewing a profit and loss statement or your company’s other financial statements, and it’s clear that the concept of total profit might be a bit more complex than you originally thought. So, before we jump into how to calculate total profit for your small business, let’s quickly touch on what, exactly, total profit is.
Your business brings in a certain amount of money each year; that’s what’s called your gross income. But it’s not like you get to pocket every dollar that flows into your small business. Every company has a variety of business expenses from paying your employees to marketing your business to general operating expenses—and those expenses will have an impact on your bottom line.
Your total profit (or net profit) is how much money you have left over after you factor in all of your business expenses. In other words, it’s the percentage of your total revenue that you (and your business) get to keep.
Why is understanding your total profit so important?
As mentioned, having a clear understanding of your company’s cash flow, expenses, and net profit is a must for small business owners. But why is it so important?
There are a variety of reasons you need to have a clear understanding of your business’ total profit, including:
- It’s an indicator of your company’s financial health. Understanding your total profit is important because it can help you gauge the state of your company’s financial health. Generally, the more profit your business is driving, the better your company is doing.
- It helps you set realistic budgets. You can’t decide where and how to spend money in your business if you don’t know how much money you actually have. Digging into your company’s total profits can help you understand how much budget you have to invest in your business—and can help you make decisions on the best ways to spend that budget.
- It supports growth. In the same vein, understanding your business’ net profit can help you better take advantage of growth opportunities. For example, if you know your company has a large profit margin, you can spend more on marketing initiatives or hiring a new team member or consultant to help take your business to the next level.
- It factors into your ability to secure funding. Your total profit and overall profitability plays a huge role in your ability to secure funding from outside lenders. Understanding how much profit your company is generating before you apply for a loan can help you be better prepared for the process—and, if necessary, to get your finances in better shape before submitting an application.
The total profit formula: How to calculate the total profit for your business
Clearly, understanding your total profit—and having a clear picture of your bottom line—is important. But how, exactly, do you calculate that number?
Net sales – Cost of goods sold – Expenses = Total Profit
Let’s break each of those individual elements down a bit further:
Net sales are your company’s gross sales (also known as total sales) minus anything you had to pay out in returns, discounts, or other allowances. So, for example, let’s say your company does $1 million in sales in a given year. That’s your gross profit. But if you have a 10 percent return rate, you need to factor that in—so your net profit would be $900,000 ($1 million – $100,000 in returns).
Cost of goods sold
Cost of goods sold (often shortened to COGS and sometimes referred to as “cost of sales”) is how much it actually costs your company to produce your products or services before selling them to your customers (including manufacturing, shipping, and some labor costs).
So, for example, let’s say you sell your product for $30—but it costs your business $7 to actually create that product. That $7 is your COGS.
This first part of the equation—net sales minus cost of goods sold—gives you your business’ gross profit. But if you want to get to your business’ total profit (or net profit) you have to take the equation one step further.
To get to your total profit, you also need to deduct any additional business expenses. This can include:
- Office supplies and equipment
- Labor costs (including salaried employees, hourly employees, temporary workers, and contractors or consultants)
- Employee benefits
- Marketing and advertising costs
- Depreciation expenses
Once you subtract all of your additional expenses from your earlier figure of net sales minus cost of goods sold, voila! You have your business’ total profit.
Factors that can impact total profit
Typically, businesses aren’t static; sales, costs, and expenses are constantly changing. And all those variables will play into your total profit at any given time.
There are a variety of factors that can impact your total profit (either positively or negatively), including:
- Seasonality. Depending on your business model, you might have times during the year where sales are higher than others. Or, on the flip side, you might have a time of the year where you get hit with a number of large expenses—both of which could impact your total profit at the time.
- Unexpected expenses… While many business expenses are fixed, just as many are variable. A large, unexpected purchase (for example, having to replace a piece of expensive equipment) can have a negative impact on your business’ profitability, but it’s typically not a cause for alarm. Every business has unexpected expenses—and as long as they’re the exception and not the rule, they’re not a significant indicator of your company’s overall financial health.
- …or unexpected revenue. On the flip side, there are also situations where your company might get an influx of unexpected cash (for example, if a client with multiple past due invoices pays their outstanding balances all at once) that could push your total profit higher.
Any of these factors can push your total profits higher or lower on any given day—and if you’re only calculating your total profit on a yearly basis, it could give you a skewed picture of your company’s actual profitability. For a clearer, more consistent number, make sure to calculate your total profits on a quarterly basis, which will give you a more comprehensive view of your company’s financials—and help you get a more accurate idea of your total profits.
Understanding your company’s profitability is key to taking your small business to the next level
When you look at your company’s income statement, you want to understand what every single number means and how it plays into your overall company’s profitability. And now that you know exactly how to calculate the total profit for your business, you have the formula you need to make sense of your business’ financials—and use that information to grow your business operations and take your company to the next level.