Profit Formula in Accounting

The 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 the key component of operating margin, earnings per share, profitability ratios, etc. There are various statutory guidelines and local GAAPs that all corporations must follow while calculating the profits for any given period. It ensures transparency and allows better comparability in the company’s results.

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 (EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business’s performance with that of its competitors.read more).

The formula for profit in accounting is:-

Profit Attributable to Shareholders = Revenue – Cost of Revenue – Selling and Maintenance Expense – General and Administrative Expense – Depreciation and Amortization – Research and Development Expense + Other Income – Tax Provision +/- Extraordinary ItemExtraordinary ItemExtraordinary Items refer to those events which are considered to be unusual by the company as they are infrequent in nature. The gains or losses arising out of these items are disclosed separately in the financial statement of the company.read more not About Ordinary Business

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Steps to Calculate Accounting Profit

Calculation Examples of Profit

Let us see some simple to advanced examples of the profit equation to understand it better.

  • Determine the company’s total revenue from the core business activity. Then, from revenue, deduct the total cost of revenue incurred for earning the company’s gross revenue. That will help arrive at gross profit and gross margin. The cost of revenue includes salary cost, finance expense, cost of inventory, and such expenses directly related to the business. 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 the below expense: – a. Selling and maintenance expense b. Depreciation and amortization c. Research and development expenses. d. It will give the operating income of the company For operating income, add other incomes like interest, profit on the sale of the investment, etc., to arrive at a 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. From profit before tax, deduct tax provision for the given period. It will provide profit after tax. Every business will have a few unwanted gains or losses incurred during the financial year, which are not ordinary, like the debtor’s bankruptcy, winning/losing any legal suit, etc. Adjust such extraordinary items to profit after tax, which will provide income attributable to shareholders.

#1 – Microsoft Inc.

Below are the various incomes and expenses of Microsoft Inc., calculated profit attributable to the shareholders: –

Solution:

As per the given profit equation, operating income can be derived as follows: –

Operating Income = 12,789 – 1,144 – 1,200 – 452 – 306

Operating Income = 9,687

Calculation of profit income attributable to shareholders can be done as follows: –

Income Attributable to Shareholders = 9,687 + 122 + 219

Income Attributable to Shareholders = 10,028

Thus, Microsoft Inc. has earned a profit from operating income of $9,687 million 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: –

Bifurcate the expense under different heads and calculate the profit attributable to shareholders.

As per the given profit formula, operating income can be derived as follows: –

Operating Income = 15,619 – 1,434 – 1,918 – 403 – 1,691 – 1,504 – 566 – 4,012 – 4,162 – 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 = – 28

All the expenses are bifurcated into various heads based on their nature. While bifurcating the expense, one must consider whether the expense is directly related to operations. If it is directly related to operations, 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 selling and maintenance, general and administrative expenses, etc., which are considered below-the-line expenses.

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: –

As per the given formula, operating income can be derived as follows: –

Operating Income = 17,832 – 1,738 – 2,324 – 2,049 – 1,823 – 686 – 22 – 5,044 – 488

Operating Income = 3,658.

Income Attributable to Shareholders = 3,631 + 111 – 1,863

Income Attributable to Shareholders = 1,879

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, it will form part of the cost of revenue. Otherwise, it will form part of selling and maintenance, general and administrative expenses, etc., considered the line expense.

Thus, Apple Inc. has earned profit from operations of $3,658 million for the given period and $1,879 million for the given financial year.

As per the given formula, operating income can be derived as follows:-

Operating Income = 9,179 – 869 – 911 – 2,522 – 1,162 – 1,024 – 2,372

Operating Income = 319

Income Attributable to Shareholders = 140 + 55 – 931 + 953

Income Attributable to Shareholders = 217.

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, it will form part of the cost of revenue. Otherwise, it will form part of selling and maintenance, general and administrative expenses, etc., considered below-the-line expenses.

Relevance and Uses

Determining the correct profit formula is of utmost importance as:

  • Profit is considered a key indicator of operating margin.Profit is regarded 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 make strategic decisions like continuing the business line or diversifying or divesting 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.

This article is a guide to Profit Formula. We discuss the calculation of profit, profit equation, examples of profit, and its interpretations. You can learn more about financing from the following articles: –

  • Formula of Economic Profit Formula Of Economic ProfitEconomic profit refers to the income acquired after deducting the opportunity and explicit costs from the business revenue (i.e., total income minus overall expenses). It is an internal analysis metric used by the organizations along with the accounting profits.read moreCalculate Operating Expense (OPEX)Calculate Book ProfitCalculate Book ProfitBook Profit is the profit amount that a business earns from its operations & activities but has not been realized yet. It is not tracked by analysts or stakeholders & its calculation is relevant only to evaluate a Company’s tax liability. read more