Small business owners may have claimed they earn 1 million Naira profit or even higher. But, when examined thoroughly, it may be that the entrepreneur is talking about sales as profit. Or even when it is profit, it wasn’t calculated properly. To begin, let’s look at some misconceptions about profit.
Misconception about profits
Profit is sales. As already stated, some entrepreneur thinks profit is sales. This isn’t true. Profit is the difference between total income earned minus total business expenses.
I made a profit whereas it was cash. Some entrepreneurs may claim they make it, but they are telling you the balance in their business bank account. This isn’t profit but cash.
My business capital increased. Yes, profit increases capital. But was it an accounting profit or something else? Accounting profit applies the accrual basis of accounting to know the actual profit for the period under consideration.
It is best to seek the service of an accountant to know fully well what profit is all about. But here, I will give you a guide on knowing your monthly profit.
You can learn more about the meaning of profit, income, revenue, gains, and expenses. I have written articles on them already.
What you should know about Profit
Profit is simply income minus expenses. But the income and expenses used to take place within the period under consideration. What do I mean? Let say part of the expenses you incurred in January include rent of NGN 120,000 for one year. You can’t consider all this as your rent expenses for January. Why? The rent expense is for 12 months. Therefore, you need to calculate the expense for one month, to know your rent for January you are calculating your business profit.
Another way to look at it is this. Let’s say for January, you haven’t paid the electricity bill. Does this mean you will omit this expense from profit calculation? No! You must include that month’s bill when computing profit so that you won’t get the wrong profit.
In a nutshell, to calculate your profit, you must consider all income and expenses relating to the period you are interested in. If you want to know your profit for one month, then put together all items of income and expenses for that month. If you want to know the profit for a year, do the same. However, it is advisable to calculate profit every month. And also do a rough sketch of your profit daily.
Steps to calculate profit
This is only a guide. And may not provide you with all the information you need to know your profit. But I believe it will be of help.
Know your income. Firstly, you need to differentiate your revenue from your gains. Revenue arises from what you sell every day. Your business is to sell smartphones. Every smartphone you sell is your revenue. However, if you sell the television set in your store. That’s not revenue but gain. It is gained if the amount you sell is higher than the scrap price plus depreciation.
Again, you may have sold some of your items on credit and cash terms. You will need to add up all the items you sold for the month, on both terms, together. This will make up the revenue for the month.
Calculate the cost of sales. You purchase goods from suppliers, transport the goods to the office. You may also have goods in the store. To calculate your cost of sales. Add up the total purchases you made for the goods for the month. Add the transport cost. Then minus the goods that are still in store at the end of the month. To achieve this stock-taking is necessary. A simple format can help you do this.
Know your expenses. This is the most technical part of knowing your profit. Expense is a broad term. But you can divide them into operating expenses, selling and distribution cost, staff cost, depreciation, and impairment loss. Let’s discuss each of these …
Operating expenses. These are the money you spend daily in the office. You spend money on fuel for the generator. You pay the electricity bill. Ensure the electrical appliances and computers are in good shape. Buy water to keep your staff and clients relaxed. Pay for subscription service for your Television set. And so on. As long as the expenses are within the office or your store, then place them as operating expenses.
Common operating expenses are office and general expenses, miscellaneous expenses, fuel for the generator, repairs of the generator, repairs of electrical appliances (this can be included in the office and general cost), computer expenses.
Selling and distribution cost. All expenses relating to selling your product and making them available at the home of the client or customer are under here. You pay for advertising your product on Facebook, Instagram, and other social media websites. Paying a logistics company like OPay or Bolt to move the goods to the customer. Or if you own a delivery van, the fuel for the van, salary of the delivery man and sales representatives may fall under here. You can as well put the salary on staff cost instead of on selling and distribution cost.
Staff cost. This is the amount you paid as salary to all individuals working for your business. It doesn’t include the amount you paid the person who serviced your generator or repaired your delivery van. The amount recorded here is the one before you deduct tax. For example, if you and the employee agree to NGN 50,000 as salary per month. This is what should be recorded as staff cost though you will need to deduct tax.
Depreciation. This is the cost of using certain assets for your business every day. These assets include but are not limited to the following: office car, delivery van, generator, furniture, and computers. You will need to decide how to charge part of the cost of these assets as depreciation. The most simple method is called the straight-line method. Here, you charge an equal amount every month for each asset type.
For example, if you have bought a computer for 120,000 Naira and it is expected to last for 5 years. It means that you should charge (120,000 ÷ 5) 24,000 Naira per year and (24,000 ÷12) NGN 2,000 per month. You can apply this logic to other asset types.
Impairment loss. For selling your product on credit terms it is best to calculate impairment loss for the amount owed by your debtors every month. You can do this with this simple format. This is known as the probability matrix. You can create your own subjective matrix.
You can use a single percentage to calculate impairment loss. This is done by multiplying the rate you choose by the total account receivable. An impairment loss is calculated so that the owner will not earn all profit on credit sales. It is also necessary to check credit risk. That’s the risk that customers will not pay. Therefore, deducting impairment loss is similar to mitigating against risks that customers will not pay their debts.
Place the income and expenses in a format. This format may be a good guide.
With this guide, you may have calculated your profit for the month. You can repeat the process every month. So that at the end of the year, all you need to do is sum up each item in the monthly statement of profit or loss for the one year to get the year’s profit.
To calculate the profit you earn per month, you must consider only the revenue and expenses made for the month. Including other months’ expenses for the current month will give you a wrong profit figure. Follow this rule and you may succeed.