How to find accounting profit

By Indeed Editorial TeamFebruary 14, 2022Businesses continuously monitor their financial information in order to assess their success and identify areas of improvement. There are a

How to find accounting profit

By Indeed Editorial Team

February 14, 2022

Businesses continuously monitor their financial information in order to assess their success and identify areas of improvement. There are a variety of methods for evaluating financial health and performance, including accounting profit, or financial profit.

In this article, we define accounting profit and why it's important, identify how often businesses should calculate it and explain how to do so with an example. We also compare it to other common types of profits.

What is accounting profit?

Accounting profit, also called "financial profit" or "bookkeeping profit," refers to the total earnings of a company after deducting all explicit costs associated with doing business from the total revenue earned. It's similar to the net income or profit of a business as reported on a financial statement, which is the difference between a business's revenue and operating costs based on the generally accepted accounting principles (GAAP). GAAP refers to the guidelines created for recording and reporting financial information to provide accounting professionals with standard financial documents to use throughout the industry.

Here's the formula to use for calculating accounting profit:

Accounting profit = total revenue - explicit costs

Accounting profit includes both indirect and direct costs or expenses associated with the business. This includes depreciation and amortization, interest, operating expenses and taxes. Depending on the business, it may also include expenses like advertisements, cost of goods sold, labor wages, overhead costs, raw materials and sales and marketing costs.

Read more: Guide To Generally Accepted Accounting Principles (GAAP)

Why is accounting profit important?

Accounting profit is an important figure for businesses to be familiar with, as it relates to the business's revenue and performance. It represents the specific monetary difference between the expenses a business pays off compared to how much revenue it generates. Managers or other business leaders may use this amount to evaluate the business's current performance and compare its financial success to its competitors within the industry.

How often should you calculate accounting profit?

It's important to calculate accounting profit often, as this aspect of a financial statement provides useful insight for business decisions. However, the exact frequency for how often to calculate this figure varies based on factors like the business's current profitability, economic statement and size. Businesses need to calculate accounting profit a minimum of once per year to file their taxes, but many of them may calculate it at the end of every month to best monitor their performance.

Related: Types of Financial Statements and What They Report

How to calculate accounting profit

Follow these steps to calculate accounting profit:

1. Determine your total revenue

Review your financial statements to determine your total revenue. Be mindful of the period in which you want to calculate the accounting profit. For example, if you want to determine your accounting profit for the calendar year, add together the total revenue of each month to get the amount you want.

2. Determine your explicit costs

Determine your total explicit costs for the period. Add each of these amounts together. Some examples of what your explicit costs may include are:

  • Cost of goods sold
  • Depreciation
  • Employee costs
  • Extraordinary loss
  • Interest
  • Inventory costs
  • Non-operating costs
  • Operating expenses
  • Sales and marketing costs
  • Selling and administrative expenses
  • Taxes
  • Wages

Read more: Explicit Costs: Definitions and Examples

3. Determine the accounting profit

Use the total revenue amount and explicit costs to determine your accounting profit. Subtract the explicit costs from the total revenue. The result is your accounting profit.

Example of how to calculate accounting profit

Shelby's Shoes is a small local boutique, and the owner wants to determine the business's accounting profit for the year. Shelby determines the total revenue for the year is $250,000.

To calculate the explicit costs, Shelby adds together $100,000 for costs of goods sold, $80,000 for employee costs, $15,000 for selling and administrative expenses, $5,000 for depreciation, $2,500 for interest and $12,500 for taxes for a total of $215,000. Shelby subtracts $215,000 for explicit costs from the total revenue of $250,000 for an accounting profit of $35,000.

Accounting profit vs. economic profit

Accounting profit and economic profit both consider explicit costs in the calculations. Economic profit, however, includes implicit costs or opportunity costs, which are potential benefits sacrificed when choosing a different option.

While economic profit factors in alternative actions a business could've made, accounting profit only considers measurable book values. However, some favor economic profit for decision-making because of the possibilities it encompasses.

Read more: Economic Profit vs. Accounting Profit: Definitions and Examples

Accounting profit vs. underlying profit

Underlying profit is a subjective calculation, whereas accounting profit is an objective calculation. When determining underlying profit, you may eliminate unusual, infrequent one-time charges, such as a one-time business-related repair or uncommon or irregular events that occur and affect earnings, such as natural disasters.

The result is an amount that's consistent with what the business would earn when running with normal operations. Accounting profit, however, considers all values and expenses incurred, regardless of how frequent or infrequent and normal or abnormal they are.

Accounting profit vs. cash profit

Cash profit reflects profits related to real cash inflows and outflows. Accounting profit represents a more theoretical representation of cash flows. Some prefer to use cash profit as it may better represent the real profits of a business, more accurately representing a business's economic viability.

Related: Cash Flow vs. Accounting Income: What's the Difference?

Accounting profit vs. taxable profit

Taxable profit is an amount determined based on accounting profit to identify what value to use for tax declaration. Taxable profit composition varies based on different regional tax authorities, but a business alters its accounting profits based on tax laws and accounting standards. Businesses are responsible for identifying the expenses and income items that their areas' taxes laws can and cannot recognize, such as capital gains on the sale of long-term assets, dividend income, interest income and operating earnings.

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