How to Calculate a Profit in Business

Any business that does not make a profit will die. Any business that does not make a profit will die. Any business that does not make a profit will die. Did you notice that the three preceding sentences are the same? You are right and no, that’s not a typo. It’s my way of drawing your attention to how important it is for you to ensure that your brand is profitable.

A lot of businesses die pre-maturely not because of location, products/offerings or even lack of customers. Rather, many businesses die because their owners ormanagers do not understand how to calculate a profit.

Do you know how to calculate a profit? Is your business profitable? Hold that thought.

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Sales is not Profit

My experience as a business person started with my mom. She taught me the essentials of running a profitable business. She used to manage a gift store in the center area of our town and at that time, there were about five other gift store owners. The inventory in these stores was similar but my mom’s store prices were the highest. I just couldn’t wrap my head around why the stores sold similar items yet my mom’s store prices were considerably high.

On some occasions, we lost some prospects for the other stores because of high prices but my mom seemed not to be bothered. To me, she seemed to prefer to lose her customers to the other businesses. I wondered why she let go of the opportunity to make a sale instead of taking advantage.

One day, I asked her why that was. She explained to me that most of the other store owners were running at a loss. Why? The reason was that they weren’t calculating their profit the way they should. By the time she broke things down to me, I understood the difference between sales and profits.

High Sales Don’t Guarantee a Profit

One of the indices that a lot of businesses use in determining whether they are making a profit is sales. However, just because you are making high sales is not a guarantee that you are making a profit. You can have high sales and still be running at a loss. When I say this to some business owners, they look at me confused. This is because they are yet to understand that sales is not equivalent to making a profit. You can clear your inventory in the shortest amount of time but if you struggle from month to month to pay your bills, you already know that there is a problem.

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How Not to Calculate a Profit

Most people calculate profit using the cost price only. They add a percentage to the cost price and then arrive at a selling price. This way of calculating profit is what tricks many business owners into thinking they are making a profit when in fact they are running at a loss. The no-profit business model is usually not immediately noticeable because business owners might still be able to restock. However, over time, the real deal will begin to uncover itself. Unpaid salaries, unpaid debts, and inability to restock will begin to hit and the business will eventually die. To build a profitable brand, you need to learn how to properly calculate profits.

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How to Calculate a Profit

As a small business owner, your business success is not determined by how many customers you have or how much sales you make. It is determined by how much profit you make.

The key to pricing an item right is to go beyond just considering the cost price but by also considering your overhead costs. Overhead costs may include transportation costs, telecommunications, electricity, office supplies, salary, rent and every other thing that might not be directly related to the item you intend to sell but have a connection to it. 

Once you determine the overhead costs, you then add that to the face value for a new value called adjusted cost price. Your profit margin on your adjusted cost price should be between 25% and 30%. 

(CostPrice + Overhead cost ) = Adjusted Cost Price

Adjusted Cost Price * 30% = Selling Price

I used 25% – 30% as a standard but that does not necessarily mean you cannot add a profit margin of 50%, 100%, 200% etc. to your cost price. You are free to add whatever margin makes sense to you and your brand. What is most important is that you are not ripping off your customers. You must always provide value that is commensurate with the type of service you are providing your customers. 

Thank you for reading. Do you struggle with calculating profits for your business? Leave a comment below and remember to share this post with a friend.