Gross Profit Computation Basics

Computation of Gross Profit

• Profit is a financial gain from a transaction or business activity, calculated as income exceeding costs or the final asset value exceeding its initial value.
• Profit equals total revenue minus total expenses and is the money a business makes during an accounting period for reinvestment or retention.
• Accurately determining profit is essential for judging a business's financial health, pricing goods/services, and paying employees.
• To increase profit, add up all money made in a set period like quarterly or monthly.
• Include income from products sold, services, membership fees, taxes, fees, and sales of resource rights.
• Subtract any cash refunded to customers for returns or disputes to accurately calculate total income.
• For example, a publishing business that sold books for P20,000, intellectual property rights for P7,000, and promotional materials for P3,000 has a total income of P30,000.
• The module covers computing for profits and financial statements.
• Previous knowledge of adding and multiplying numbers helps in completing this module.
• After studying this module, one should be able to compute for profits, define profitability, liquidity and solvency and identify commonly used profitability ratios.
• Earning a profit is the goal for any business.
• The difference between the money earned from selling an item and the cost to produce that item is the profit.

The Gross Profit

• Profitability ratios are a group of financial statements that determine a business operation's profitability.
• The gross profit rate on a product is net sales less the cost of goods sold.
• For example, XYZ Trading had net sales of P734,000.00, a cost of sales of P577,000.00, and a gross profit of P157,000.00 in 2017.
• Profit is gross income, and the amount of gross profit provides information on revenue earned from sales.
• Cost refers to the purchase price of the product.
• The gross profit margin = (gross profit / net sales)
• The gross profit rate measures the percentage of gross profit to sales, indicating the profit from selling a product.
• For XYZ Trading, the gross profit rate is 21.39%, implying a cost ratio to sales to 78.61%.
• Gross profit rate helps determine the amount of margin on sales, whether the amount of gross profit can cover operating the business, and helps entrepreneurs set the selling price.

The Operating Profit

• Operating profit margin is the excess of gross profit minus operating expenses.
• Operating profit margin is the second level of revenue in the income statement and includes all the operating expenses.
• Operating expenses are expenses incurred during a particular period and don't provide benefits to any future period.
• If there are no financing charges like interest, tax, the operating profit margin is the net income.
• Operating profit margin of the business measures the percentage of profit after deducting the cost of sales and operating expenses.
• A higher operating profit margin is favorable.

Net Profit

• Income statements show the net profit margin and is the third level in the revenue.
• Business is only given consideration like interest expense and income tax.
• For example, when an operating profit margin is P67,000.00 and income tax is P20,000.00, the net profit margin is P46,900.00.
• XYZ Trading's income statement only deducted income tax from the operating profit margin.
• Net profit margin rate = Net Profit / Net Sales
• For XYZ Trading, the net profit margin rate is 6.39%
• This profit rate must be compared with similar business' rates within the industry.

Liquidity

• Liquidity ratios analyze the liquidity status of the business.
• Current ratio = Current assets / Current liabilities
• Quick ratio = (Current assets – Inventories) / Current liabilities or (Cash and equivalents + Marketable securities + Accounts receivable) / Current liabilities
• The quick ratio measures its short-term obligations with its most liquid assets and excludes inventories from its current assets.
• Financial statements communicate past successes and future expectations and records all operating results such as sales, expenses, and profits or losses.
• The Return of investment (ROI) measures the amount of net income per peso invested in the business.
• As a future entrepreneur, remember that nothing is permanent in the field of entrepreneurship.
• Creativity should be applied by regularly evaluating the market environment and responding to the changes in them.
• The owner of a small business has considerable freedom to manage and operate business.
• For the entrepreneur to perform entrepreneurial activities correctly, it is important that the business activities are performed correctly.
• To increase your sales, improve by looking at the money you earn from sales, and increase customers, sales volume of goods/services, and sales price
• Profit = the money from sales, the cost of stock if you're selling and all the expenses you incurred.
• Income earned by the business is the sales and gross profit
• Business expenses include commissions, discounts, and fixed expenses.