Note that you will need to subtract any amount of cash refunded to customers for returns or disputes in order to find an accurate figure for your total income. It’s easier to understand the process of calculating a business’s profit by following along with an example. Let’s say that we own a small publishing business. In the last month, we sold $20,000 worth of books to retailers in the area. However, we also sold the rights to one of our intellectual properties for $7,000 and received $3,000 from book retailers for official promotional materials. If these represent all of our revenue sources, we can say that our total income is $20,000 + $7,000 + $3,000 = $30,000.
In our example, let’s say that our business spent $13,000 total during the month that it made $30,000. In this case, we’ll use $13,000 as our value for total income.
In our example, since we have accurate, definitive figures for our income and expenses, calculating our business’s profit is fairly simple. Subtracting our expenses from our income gives us $30,000 - $13,000 = $17,000 profit. Since we’re the owners, we can use this money to buy a new printing press for our publishing company, increasing the number of books we can print and potentially earning us more profit in the long run.
In the next section, we’ll explore a step-by-step breakdown of a business’s sources of income and expenses much as an actual income statement would.
To illustrate the process of breaking down a business’s income and expenses, let’s work through an example problem in this section. Let’s say that we own a small company that makes high-end sneakers. For this quarter, let’s say that we sold $350,000 worth of sneakers. However, due to a recall, we we had to pay out $10,000 in refunds. We also had to pay $2,000 for unrelated returns and discounts. In this case, our net sales are $350,000 - $10,000 - $2,000 = $338,000.
In our sneaker company example, our company needs to buy fabric and rubber to make its sneakers and also needs to pay factory workers to assemble the raw materials into wearable products. If we say that we spent $30,000 on fabric and rubber and paid our factory workers $35,000 collectively this quarter, our business’s gross income is $338,000 - $30,000 - $35,000 = $273,000. Note that in situations where the business in question doesn’t sell any physical products (like, for instance, if the business is a consulting firm), a value similar to COGS called cost of revenue is used. Cost of revenue includes expenses directly related to your business making its sales, like direct labor costs and sales commissions, but excludes indirect expenses like employee salaries, rent, utilities, and so on. [12] X Research source
For our sneaker company example, let’s say that we paid our non-factory employees (sales force, managers, etc. ) $120,000 collectively. We also paid $10,000 in rent and utilities and spent $5,000 running ads in trade magazines. If these are all of our operating expenses, we would subtract $273,000 - $120,000 - $10,000 - $5,000 = $138,000.
In our sneaker company example, let’s say that the machinery used to manufacture our sneakers cost $100,000 and has a 10-year lifespan. Assuming straight-line depreciation, the machinery depreciates by $10,000 per year, or $2,500 per quarter. If this is our only depreciation/amortization expense, we can subtract $138,000 - $2,500 to get our operating income, $135,500.
Let’s say that our sneaker company is still paying off the initial loan we used to start the business. In the last quarter, we paid $10,000 towards our loan. We also bought a new shoe-making machine for $20,000. If these represent all of our extraordinary expenses for the quarter, we can subtract $135,500 - $10,000 - $20,000 = $105,500.
Let’s say that, in the last quarter, we sold an old shoe-making machine for $5,000 and we licensed our logo for use in another company’s advertisements for $10,000. In this case, we would add our one-time revenues to our running total: $105,500 + $5,000 + $10,000 = $120,500.
In our example, let’s say that, based on our business’s level of pre-tax income, we are taxed $30,000. Subtracting $120,500 - $30,000 = $90,500. This represents our business’s net income, which means we profited $90,500 for the quarter. Not bad!
