Profit Formula in Accounting
Profit Formula in accounting calculates the net gains or losses incurred by the company for any given period by subtracting total expenses from total sales. Profit is the key indicator of the performance of any company. Profit is considered as the key component of Operating margin, Earning per shareEarning Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more, profitability ratiosProfitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more, etc. There are various statutory guidelines and local GAAPs, which all the corporations have to follow while calculating the profits for any given period. It not only ensures the transparency but also allows the better comparability in the results of the company.
Profit is the walkthrough through which any non-professionals can understand how the company has arrived at a profit after tax (PATPATProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business.read more), profit before taxProfit Before TaxPretax income is a company's net earnings calculated after deducting all the expenses, including cash expenses like salary expense, interest expense, and non-cash expenses like depreciation and other charges from the total revenue generated before deducting the income tax expense.read more (PBT), Earnings before interest tax depreciation, and amortization (EBITDA).
The formula for profit in accounting is:
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For eg:
Source: Profit Formula (wallstreetmojo.com)
Steps to Calculate Accounting Profit
Below is the detailed explanation of the steps of the Profit equation:
Step 1: Determine the total revenue of the company from the core business activity.
Step 2: Then, from revenue, deduct the total cost of revenue incurred for earning the gross revenue of the company; this will help in arriving at gross profit and gross margin. Cost of revenue includes Salary cost, finance expense, cost of inventory, and such expense directly related to the business.
Step 3: From gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more, deduct below expense:
- Selling and maintenance expense
- General and Administration expense
- Depreciation and Amortization
- Research and Development Expense.
It will give the Operating income of the company.
Step 4: To Operating income, Add Other income like interest, profit on the sale of the investment, etc., to arrive at Profit before taxesProfit Before TaxesProfit before tax (PBT) is a line item in a company's income statement that measures profits earned after accounting for operating expenses like COGS, SG&A, depreciation & amortization, and non-operating expenses. It gives the overall profitability and performance of the company before making payments in corporate taxes.read more.
Step 5: From Profit before tax, deduct tax provision for the given period. It will give profit after tax.
Step 6: Every business will have few unwanted gains or losses incurred during the financial year, which are not ordinary in nature like the bankruptcy of the debtor, winning/losing of any legal suit, etc. Adjust such extraordinary items to Profit after tax, which will provide income attributable to shareholders.
Calculation Examples of Profit
Let’s see some simple to advanced examples of the profit equation to understand it better.
#1 – Microsoft Incorporation
Below are the various incomes and expense of Microsoft Inc., calculate profit attributable to the shareholders:
| Particulars | Amount ( in $) |
|---|---|
| Salary and Wages | 322 |
| Interest Expense | 669 |
| Interest Income | 219 |
| Cost of Inventory | 43,410 |
| Sales Promotion Expense | 1,144 |
| Professional Fees | 1,200 |
| Fees | 452 |
| Dividend Income | 122 |
| Depreciation | 306 |
| Revenue from Sale of IT Products | 57,190 |
Solution:
As per the given profit equation, Operating Income can be derived as follows:
Operating Income = 12789 – 1144 – 1200 – 452 -306
Operating Income = 9687
Calculation of profit income attributable to shareholders can be done as follows:
Income Attributable to Shareholders = 9687 + 122 + 219
Income Attributable to Shareholders will be –
Income Attributable to Shareholders = 10028
Thus, Microsoft Inc has earned profit from operating income of $9687million for the given period and $ 10,028 Million of profit attributable to shareholders.
Example #2 – Alphabet Inc
Below are the particulars of Alphabet Inc., for the financial year:
| Particulars | Amount ( in $) |
| Salary and Wages | 403 |
| Interest Expense | 838 |
| Interest Income | 274 |
| Cost of Inventory | 54,436 |
| Sales Promotion Expense | 1,434 |
| Professional Fees | 1,504 |
| Legal Fees | 566 |
| Dividend Income | 152 |
| Depreciation | 383 |
| Revenue from Sale of IT Products | 71,716 |
| Provision for Doubtful Debt | 4,012 |
| Rent Expense | 4,162 |
| Insurance Expense | 1,918 |
| Subscription Expense | 403 |
| Travel Expense | 1,691 |
| Staff Welfare Expense | 420 |
Bifurcate the expense under different heads and calculate the profit attributable to shareholders.
Solution:
As per the given profit formula, Operating Income can be derived as follows:
Operating Income = 15619 – 1434 – 1918 – 403 – 1691 – 1504 – 566 – 4012 – 4162 – 383
Operating Income = -454
Calculation of profit loss attributable to shareholders can be done as follows:
Loss Attributable to Shareholders = -454 + 274 + 152
Loss Attributable to Shareholders will be –
Loss Attributable to Shareholders = -28
Explanation:
All the expenses are bifurcated into various heads if expenses based on their nature. While bifurcating the expense, one has to keep in mind whether the expense is directly related to operations or not. If it is directly related to operations, then it will form part of the cost of revenueThe Cost Of RevenueThe cost of revenue is the total expense incurred from manufacturing to delivering a product or service to the customer. It reflects all direct costs associated with the product or service delivered and is reflected in a company's income statements.read more. Otherwise, It will form part of either Selling and maintenance, General & Administration expense, etc., which are considered as below the line expense.
Thus, Alphabet Inc has incurred a loss from operations of $454 million for the given period and a loss of $28 Million for the given financial year.
Example #3 – Apple Inc
Below are the particulars of Apple Inc., for the financial year:
| Particulars | Amount ($) |
| Wages | 488 |
| Interest Expense | 1,015 |
| Insurance Claim Lodged and Accepted | 111 |
| Communication | 387 |
| Interest Income Expense | 332 |
| Cost of Inventory | 65,983 |
| Employee Stock Obligation Expense | 100 |
| Bank OD Interest Expense | 87 |
| Sales Incentive Expense | 1,738 |
| Audit Fees | 1,823 |
| Court Fees | 686 |
| Bank Guarantee Expense | 63 |
| Brokerage Expense | 22 |
| Dividend Income | 184 |
| Depreciation and Amortization | 464 |
| Revenue from Operations | 86,928 |
| Provision for Insolvency of Debtor | 1,863 |
| Office Rent Expense | 5,044 |
| Insurance Expense | 2,324 |
| Subscription Expense | 488 |
| Commutation Expense | 2,049 |
| Staff Welfare Expense | 509 |
Bifurcate the expense under different heads and calculate the profit attributable to shareholders.
Solution
As per the given formula, Operating Income can be derived as follows:
Operating Income = 17832 – 1738 – 2324 – 2049 – 1823 – 686 – 22 – 5044 – 488
Operating Income = 3658
Calculation of profit income attributable to shareholders can be done as follows:
Income Attributable to Shareholders = 3631 + 111 – 1863
Income Attributable to Shareholders will be –
Income Attributable to Shareholders = 1879
Explanation:
All the expenses are bifurcated into various heads if expenses based on their nature. While bifurcating the expense, one has to keep in mind whether the expense is directly related to operations or not. If it is directly related to operations, then it will form part of the cost of revenue. Otherwise, It will form part of either Selling and maintenance, General & Administration expense, etc., which are considered as below the line expense.
Thus, Apple Inc has earned profit from operations of $3658 million for the given period and profit of $1879 Million for the given financial year.
Example #4 – Amazon.in
Below are the particulars of Amazon.in., for the financial year:
| Particulars | Amount ($) |
| Insurance Claim Lodged & Accepted | 55 |
| Communication | 193 |
| Inventory Consumed | 32,991 |
| Product Development Cost | 2,372 |
| Impairment | 481 |
| Profit from Sale of Plant A | 953 |
| Forex Conversions | 60 |
| Interest Expense | 43 |
| Sales Commission | 869 |
| Audit Fees | 911 |
| Letter of Intent Fees | 31 |
| Dividend Income | 92 |
| Depreciation and Amortization | 232 |
| Revenue from Operations | 43,464 |
| Loss due to Fire | 931 |
| Rental | 2,522 |
| Insurance Expense | 1,162 |
| Periodical | 244 |
| Transportation Expense | 1,024 |
| Salary Expense | 254 |
| Tax Provision | 271 |
Bifurcate the expense under different heads and calculate the profit attributable to shareholders.
Solution
As per the given formula, Operating Income can be derived as follows:
Operating Income = 9179 – 869 – 911 – 2522 – 1162 – 1024 -2372
Operating Income = 319
Calculation of profit income attributable to shareholders can be done as follows:
Income Attributable to Shareholders = 140 + 55 – 931 + 953
Income Attributable to Shareholders will be –
Income Attributable to Shareholders = 217
Explanation:
All the expenses are bifurcated into various heads, based on their nature. While bifurcating the expense, one has to keep in mind whether the expense is directly related to operations or not. If it is directly related to operations, then it will form part of the cost of revenue. Otherwise, It will form part of either Selling and maintenance, General & Administration expense, etc., which are considered as below the line expense.
Thus, Amazon.in has earned profit from operations of $319 million for the given period and profit of $217 Million for the given financial year.
Relevance and Uses
To determine the correct profit formula is of utmost importance as:
- Profit is considered a key indicator of Operating margin.
- Profit is considered as one of the key measuring areas in competitor analysis.
- Borrowings are sanctioned based on the operating profitability of the company.
- The profit helps in determining the foreseeable future of the company.
- Profit is important to take the strategic decision like to continue the line of business or to diversify or divest the business segment.
Conclusion
The profit formula plays a major role in any income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more, as this will form the base to determine the operational matrix of the company.
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