Skip to main content
Calculating profit margins, profit calculation

How do I calculate profit? | Calculating profit margins

This article will give you an overview as to why profit it is important, the different profit formulas, and the information and records you will need as a small business owner to do a profit calculation.

How do I calculate profit?

This simplest profit formula when calculating profit for one item is: profit = price – cost

Calculating profit for a higher quantity of items involves deducting direct costs, such as materials and labour and indirect costs (also known as overheads) from sales. Under normal accounting rules, sales and expenses are included in profit when they occur, not when they are actually paid so profit will include credit sales and purchases even when they are yet to be paid.

Here is an example. 

A business buys £3,000 of stock in January and agrees to pay for it in three months’ time. It sells the stock in the month in which it purchased it (January) for £5,000 cash. The profit for the month is £2,000. 

The fact that the stock wasn’t paid for immediately is not relevant when calculating profit. The profit that is calculated will derive from the ‘profit and loss’ account and will be calculated for a set period, usually a year.

Why is profit important?

It is important for a business to understand how much profit they’ve made to give it an idea as to whether the business is successful.

With so much money going in and out of a business, it is not always easy to see whether what a small business owner is doing is actually making money. By calculating profit, it helps give some clarity.

If a business is making a profit it can:

  • expand and grow
  • attract more investment
  • employ more staff.

It is worth mentioning that profit is different to cash. Some things will affect the cash flow of the business, but won’t affect profit e.g. money taken out of the business for personal use. Likewise, some items will affect profit but will not affect cash such as provisions e.g. where a business makes an adjustment for a customer not paying.

Do personal expenses affect profit?

Unfortunately personal expenses will not reduce profit nor will cash taken out of the business for personal use. So, reducing your profits to nil and paying no tax by drawing out all of your profits as cash won’t avoid a tax bill! 

For a sole trader, personal expenses will be called drawings and include cash taken out the business for personal expenditure, such as household bills and holidays. 

Will the purchase of capital items such as cars affect profit?

The purchase of capital items – e.g. fixed assets such as computer equipment and machinery – can be allowed as business costs if they are used in the business. However, because they are assets and are therefore expected to last a long time in the business, profits are reduced over a number of years by the cost and not all in one go.

Will I pay tax on the profit figure?

The starting point for tax purposes is the profit that has been calculated from the profit and loss account. However, there are different rules with regards to what is allowable as an expense for accounts purposes and what is allowed for tax. Certain expenses are not allowed as expenses for tax purposes, such as fines and client entertaining. It is best to speak to a professional for help in this area.

Focus on what matters most with ANNA Money

ANNA is the business account and tax app that helps you automate everyday admin. Their in-app assistant creates and sends invoices, sorts your expenses, and takes care of your company tax returns – plus there's 24/7 customer support. 

Free yourself by setting up an account in less than five minutes. 

Get started
Anna BTS

Checklist: What information and records do I need to keep to calculate profit?

It is vital that books and records are kept safely as there are rules surrounding how long business records must be stored for. Information that you will need to keep to prepare your accounts is listed below. Login to save this checklist to your profile for future use – as you work through the list, any checkboxes that are ticked or unticked will be automatically saved to your profile. (To register to join and enjoy the benefits of membership click on the link at the top right of the page. It will only take a few minutes to create your profile).

You must be logged in to use this checklist

Login or Register

End of Article
Share this content

Brought to you by:

AAT Business Finance Basics

AAT Business Finance Basics are a series of online e-learning courses covering the core financial skills every business needs. They draw from AAT’s world-leading qualifications and will quickly build your knowledge on key topics including bookkeeping, budgeting and cash flow.

Visit partner's website

Register with Informi today:

  • Join over 30,000 like-minded business professionals.
  • Create your own personalised account with curated reading lists and checklists.
  • Access exclusive resources including business plans, templates, and tax calculators.
  • Receive the latest business advice and insights from Informi.
  • Join in the discussion through the comments section.