Calculating the Profit of a Business Enterprise: 3 Stages

Here we detail about the three stages for calculating the profit of a business enterprise, i.e., (i) Ascertainment of Gross Profit, (ii) Ascertainment of Operating Profit, and (iii) Ascertainment of Net Profit.

1. Gross Profit:

The gross profit is the excess of revenue over directly related cost and also termed as gross margin. Gross profit is the excess of revenue over directly related cost. However, if such estimation is negative, it is considered as gross loss. To find out whether selling of goods or rendering of services to customers has earned profit for the business or not, first of all, the gross profit is to be calculated.

The difference between net sales revenue and cost of sales or cost of services provided, is gross profit. It is worth mentioning here that the cost of sales or cost of services provided means the material consumed and related expenses incurred thereto during an accounting year.

The formula for calculating gross profit is as under:

Gross Profit = Net Sales – Cost of Goods Sold

Where,

Cost of Goods Sold = Opening Stock + Net Purchase + Direct Expenses – Closing Stock

2. Operating Profit (EBIT):

Operating profit is the excess of operating revenue over operating expenses. Operating profit is the profit earned purely through the normal operating activities of the business concern. While calculating operating profit, only operating transactions are to be taken into consideration. Operating expenses mean and include cost of goods sold and those indirect expenses which are having direct link with the operating activities of the business enterprise.

Operating incomes are those revenue which have been earned through the operating activities of the business concern. Operating activities means the activities which are necessary for the running and operation of the business and for calculating operating profit, expenses related to purely financial and non- extraneous transactions are not taken into account.

For this reason, operating profit is also known as profit before interest and tax or earning before interest and tax (EBIT). In the same way, non- operating expenses or losses such as loss by fire or loss on sale of fixed assets etc. are also not taken into account.

The operating profit can be worked as follows:

Operating Profit = Gross – Operating Expenses

Or

Operating Profit = Net Profit + Non Operating Expenses – Non-Operating Incomes

3. Net Profit:

The net profit is the excess of revenue over expenses during an accounting year and when the result of this computation is negative, it is known as net loss. The net result of operating profit, non-operating expense and non-operating income is the net profit. Non-operating expenses mean the expenses which are not having any direct link with the operating activities of the business concern viz., interest, depreciation and loss on sale of fixed asset etc. These expenses are to be deducted from the operating profit.

Similarly, non operating income means the income, though earned by the business concern during an accounting year but not having a direct nexus or relationship with the operating activities of the business concern viz., gain on sale of fixed assets, interest received on investments, commission received, rent received etc. These incomes are to be added to the operating profit.

The net profit can be worked out as under:

Net Profit = Gross Profit – Indirect Expenses + Indirect Incomes

Or

= Operating Profit – Non-Operating Expenses + Non-Operating Incomes

Or

= Net Sales – (Cost of Goods Sold + Operating Expenses + Non-Operating Expenses) + Non-Operating Income

Difference between Gross Profit and Operating Profit:

Gross Profit:

1. The gross profit is the excess of revenue over directly related cost and also termed as gross margin. However, if such estimation is negative, it is considered as gross loss.

2. Gross profit is the difference between net sales revenue and cost of sales.

Operating Profit:

1. Operating profit is the profit earned purely through the normal operating activities of the business concern.

2. Operating profit is the difference between net sales revenue and all operational expenses.

Difference between Gross Profit and Net Profit:

Gross Profit:

1. The gross profit is the excess of revenue over directly related cost and also termed as gross margin. However, if such estimation is negative, it is considered as gross loss.

2. Gross profit is the difference between net sales revenue and cost of sales.

Net Profit:

1. The net profit is the excess of revenue over expenses during an accounting year and when the result of this computation is negative then it is known as net loss.

2. The net result of operating profit, non operating expense and non- operating income is the net profit.

Difference between Operating Profit and Net Profit:

Operating Profit:

1. Operating profit is the profit earned purely through the normal operating activities of the business concern.

2. Operating profit is the difference between net sales revenue and all operational expenses.

Net Profit:

1. The net profit is the excess of revenue over expenses during an accounting year and when the result of this computation is negative then it is known as net loss.

2. The net result of operating profit, non operating expense and non- operating income is the net profit.