Accounting profit is a key metric that companies use to evaluate their financial performance. It represents the net income earned after subtracting all expenses from total revenues. Learning how to properly calculate accounting profit is an important skill for finance professionals, accountants, and business owners. In this comprehensive guide, we’ll walk through the step-by-step process of calculating accounting profit.
What is Accounting Profit?
Accounting profit also known as net income is the amount of profit left after deducting all explicit costs incurred during business operations. These costs include
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Cost of goods sold (COGS) – Direct costs attributable to production of goods sold by a company. This includes raw materials, direct labor, and manufacturing overhead costs.
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Operating expenses – Ongoing expenses needed for day-to-day business operations, like salaries, utilities, rent, supplies, etc.
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Depreciation – Allocation of fixed asset costs over their useful life. This represents wear and tear on assets like machinery equipment buildings.
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Interest expense – Interest paid on debt and loans taken by the company.
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Taxes – Income taxes paid to tax authorities based on taxable income.
Accounting profit is a key metric used by management to evaluate the company’s earnings power and profitability. It allows analysis of performance over time and comparison to industry peers. Maximizing accounting profit is a primary financial objective for most companies.
How to Calculate Accounting Profit Step-by-Step
Here are the steps to calculate accounting profit from a company’s income statement:
Step 1: Identify Total Revenues
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This is the total sales or revenues generated by the company from all products & services sold during the period.
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It is the top-line number on the income statement.
Step 2: Deduct COGS from Revenues
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COGS refers to the direct production costs of inventory sold during the period.
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Deducting COGS from revenues gives the gross profit or gross margin.
Step 3: Deduct Operating Expenses
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These include overhead, salaries, rent, utilities, and other expenses needed to run day-to-day operations.
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Deducting operating expenses gives earnings before interest, tax, depreciation, and amortization (EBITDA).
Step 4: Deduct Depreciation & Amortization
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These non-cash expenses allocate fixed asset & intangible asset costs over their useful life.
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This gives earnings before interest & tax (EBIT).
Step 5: Deduct Interest Expense
- Interest paid on debt & loans is deducted to arrive at pre-tax income or earnings before tax (EBT).
Step 6: Deduct Income Taxes
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Taxes are estimated & deducted based on the company’s tax rate.
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The resulting net income after taxes is the accounting profit.
Below is an example income statement showing the calculation of accounting profit step-by-step:
| Income Statement | Amount |
|---|---|
| Revenues | $100,000 |
| Less: COGS | $(20,000) |
| Gross Profit | $80,000 |
| Less: Operating Expenses | $(30,000) |
| EBITDA | $50,000 |
| Less: Depreciation | $(10,000) |
| EBIT | $40,000 |
| Less: Interest Expense | $(5,000) |
| Pretax Income | $35,000 |
| Less: Income Taxes (25%) | $(8,750) |
| Accounting Profit | $26,250 |
Key Points on Calculating Accounting Profit
Here are some key things to note about the accounting profit calculation:
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It follows the order of income statement line items from revenues to net income.
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Only explicit costs are deducted based on GAAP accounting principles.
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Non-cash expenses like depreciation are deducted even though no cash payment was made.
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Taxes are estimated based on the company’s tax rate.
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Irregular one-time income/expenses are included in the calculation.
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Opportunity costs or implicit costs are not considered.
Comparing Accounting Profit to Other Profit Metrics
Accounting profit is different from other types of profit metrics:
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Economic Profit – Deducts implicit costs like opportunity costs in addition to explicit costs.
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Underlying Profit – Eliminates impact of irregular one-time income/expenses.
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Taxable Profit – Used for tax filings, based on tax code not accounting rules.
Accounting Profit vs. Economic Profit
Like accounting profit, economic profit deducts explicit costs from revenue. Where they differ is that economic profit also uses implicit costs; the various opportunity costs a company incurs when allocating resources elsewhere.
Examples of implicit costs include:
- Company-owned buildings
- Plant and equipment
- Self-employment resources
For example, if a person invested $100,000 to start a business and earned $120,000 in profit, their accounting profit would be $20,000. Economic profit, however, would add implicit costs, such as the opportunity cost of $50,000, which represents the salary they would have earned if they kept their day job. As such, the business owner would have an economic loss of $30,000 ($120,000 – $100,000 – $50,000).
Economic profit is more of a theoretical calculation based on alternative actions that could have been taken, while accounting profit calculates what actually occurred and the measurable results for the period. Accounting profit has many uses, including for tax declarations. Economic profit, on the other hand, is mainly just calculated to help management make a decision.
How Accounting Profit Works
Profit is a widely monitored financial metric that is regularly used to evaluate the health of a company.
Firms often publish various versions of profit in their financial statements. Some of these figures take into account all revenue and expense items, laid out in the income statement. Others are creative interpretations put together by management and their accountants.
Accounting profit, also referred to as bookkeeping profit or financial profit, is net income earned after subtracting all dollar costs from total revenue. In effect, it shows the amount of money a firm has left over after deducting the explicit costs of running the business.
The costs that need to be considered include the following:
- Labor, such as wages
- Inventory needed for production
- Raw materials
- Transportation costs
- Sales and marketing costs
- Production costs and overhead
How to Calculate Accounting and Economic Profit
How do I calculate accounting profit?
Use the steps below as a guide to calculate accounting profit. 1. Determine total revenue. Select a time period to measure your company’s total earnings such as monthly, quarterly, or yearly. Add up the income from every revenue stream. 2. Determine explicit costs.
What is accounting profit?
Accounting profit is a metric used by management to assess the current performance of the business, as well as compare its current financial position relative to competitors across the industry. The calculation of accounting profit is as follows: For example, Gordon owns a candy shop, and he analyzes his monthly financial statements.
How often should a business calculate accounting profit?
Businesses may calculate accounting profit at least once per year to file their taxes, but to best monitor their performance, they may calculate it at the end of every month. Related: 5 Most Important Metrics for Operations Managers You can follow these steps to calculate an accounting profit: 1. Determine the company’s total revenue
What are some examples of accounting profit formula?
Some examples are wages, inventory costs, sales and production costs, taxes, etc. The accounting profit formula is: Here, Total Revenue is the total income generated by a company from the sales of goods & services. The formula for accounting profit can be derived by using the following steps:
