What is Profit?

Profit is what is left over after you’ve paid all your expenses.

The important thing to note is that profit is “what’s left over.” In other words, profit is a residual. It is the consequence of what happens in and to your business.

Some of these things are within your control, and some are outside your control. If you’re going to affect your profit, you have to focus on those things over which you have control… so, what are they?

To answer this question, it’s helpful to understand that only four specific factors determine your profit:

1. The price you charge for the products and/or seervices you sell
2. The quantity (or volume) of products and/or services you sell
3. The costs you incur directly in producing or buying the products and services you sell. (We call these variable costs because they increase or decrease as your sales increase or decrease).
4. The costs you incur whether or not you make any sales. (These are best described as fixed costs because they do not change with changes in sales volume – at least not on a day-to-day basis).

Let’s put these four things together. And for simplicity, we’ll assume you have only a single product. (Our conclusions apply whether your have 1 product of 1,000).

Suppose you sell a thing called a widget.

The widget costs you $60, and you sell it for $100.

• What you sell the widget for is the price.
• What you pay for it is a variable cost.

If you sell 100 widgets, your total variable costs are $6,000. And if you sell 50 widgets, the total variable cost is only $3,000. (It varies directly with your sales volume).

Now, if you sell a widget for $100 and it costs you $60, you have made a profit of $40 on each sale.

We call this the gross profit or gross margin.

We use this term to remind us that we still have to meet our fixed costs before we end up with a net profit.

If you sell 100 widgets and make a gross margin on each one of $40, your total gross margin is $4,000.

And if your fixed costs for such things as rent, leases, wages and insurance amount to $3,000, you end up with a net profit of $1,000.

On the other hand, if your fixed costs are more than $4,000, you incur a loss.

To read the full story about profitability, download our booklet by clicking here.

And if you need some help with the profitability of your business, then give us a call, we’d love to assist making your business the best and most profitable it can be!

Contact Indigo Financial on (08) 8212 8585 if you need help with any of your accounting and taxation needs.

Note: The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.