Book profits refer to the profit earned by the business entity from its operations and activities and is calculated by deducting all the business expenses incurred within a financial year from all the sales revenue and other income generated from the selling of goods & services within that same financial year.
Book Profit Meaning
We can define Book profit as the leftover money after the entity pays off all its expenses and as shown in the statement of profit and loss. In other words, it refers to money earned by an entity during a financial year by selling products and services deducted by all the expenses incurred during the same financial year.
How to Calculate Book Profit from Cash Profit?
Book profit, as we have discussed, is the profit as shown in profit and loss account of the entity and considered to be the actual profits because it considered all cash and non-cash transactions. Like revenue generated through sales made on credit and charging annual depreciation, in which no actual cash transaction occurs and are just book entries.
Cash profit is the surplus generated through actual cash flows occurred within an entity. That means it is calculated by subtracting all the cash outflows (including all paid expenses like salary, rent, bills, etc.) from the cash inflows (including cash sales). Cash profit can also be calculated using book profits by adding back all the non-cash expenses (like depreciation debited in Profit and loss account and subtracting the non-cash revenues (like credit sales).
Book Profit calculation Example
The Cash Profit, as calculated by Mr. Solo, the owner of a sole proprietorship firm amounted to $10,000 in the previous year based on actual recipes and payments. Mr. Solo charges an annual depreciation of $800 on its assets. The credit sales (not included in cash profit) made during the year amounted to $2300. Mr. Solo wants to find Book Profits.
= $ (10000 – 800 + 2300) = $11500
Book Profit: Financial Instruments or Investment Tools
The profits made on investments that have not been realized yet are called book profits. That means when example, the current value of securities becomes higher than the actual cost paid, and the securities are yet not sold but still owned by the holder, then such profits are termed as book profits.
Let’s say Mr. John bought 100 shares of ABC Ltd at the rate of $90 per share a year ago in January 2018. The stock during January 2019 is trading at a price of $95. John being a long term investor, is expecting the prices of the stock to rise further in the future and hence decided to remain invested.
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Hence John did not sell the stocks and calculate the profits earned during the one-year interval as follows:-
Cost Paid = 100 shares * $90 per share = $9000
Current Value = 100 shares * $95 per share = $9500
Book Profit (B – A) = $(9500 – 9000) = $500
There is a possibility that this profit might erase if the prices go down. E.g., during 2019, due to poor economic growth and high market volatility, the prices decreased to $88 per share, thus erasing all the profits and creating a loss of $2 per share.
In various countries, the calculation of book value by business entities is for taxation purposes. Book value is treated as taxable income, and a specific rate applies to the book value to calculate the amount of taxes payable.
We are discussing the two major scenarios where the use of such profits is for taxation purposes:-
#1 – MAT for Companies in India
MAT or Minimum Alternative Tax applied to companies that pay dividends to its shareholders but not pay taxes under normal Income tax provisions due to various exemptions and deductions allowed.
We calculate MAT using book profits. Here it arrives after applicable additions or deductions made to net profit, as shown in the statement of profit and loss.
#2 – Partnership Firm
In this case, it simply means the profits as computed before remuneration paid to the partner. In other words, It is calculated by adding back the salary and commissions paid to the partners (if debited in P&L account) into the net profit as per profit and loss account.
This has been a guide to what is Book Profit and its definition. Here we discuss how to calculate book profit from cash profit along with practical examples and explanation. You may learn more about accounting from the following articles –