All businesses are in the market to make a profit, even a not for proft organization should make a profit for sustenance and future operations. At the simplest level, profit means making more money than you spend. Many confuse profit with income. As a result, they can't grasp why all their income isn't getting them ahead; why no one wants to invest in their high-sales company; why the bank won't extend their line of credit.
So due to these facts, this article will address the issue of calculating and knowing whether you make a profit and more.
Most people/businesses are very good at tracking their income. Each widget sale is recorded in a book or a spreadsheet somewhere. Each check received from a client for a consulting job is recorded in the checkbook or plugged into the accounting software. Each is totaled frequently.
In reality, that's not what you made.
That's not profit. It is income. It's what's coming in. In order to figure profit you have to subtract what is going out. PROFIT = INCOME – COSTS
Costs
Your business has two basic types of costs (or expenses), fixed costs and variable costs. Fixed costs are those costs that don't change based on your level of activity. These include things like rent. Whether you produce 10 widgets per shift or 15, your rent will stay the same. Variable costs, on the other hand, are directly tied to how many units of saleable goods you produce. If you need $10 of screws to produce 100 widgets, you will need $20 worth of screws to produce 200 widgets.
Income
When someone pays you that is income. Income is usually related to production levels, but is not tied to it directly.
You may produce more or less than you sell. For instance, if you have 100 widgets in the warehouse when you receive an order for 150, you only have to produce 50 additional widgets. If you make widgets for skis, you may make 20 widget every month during the summer even though you don't sell any, just so you have enough in the warehouse when winter arrives.
So income is when you actually get paid, not when you make the product you are going to sell. Total income is just the total of all your payments received during the year.
Conclusion
On a final note, keep in mind that, to make a profit, you must be able to sell each unit for more than it cost to make it and you must be able to sell it for a price high enough to cover both the variable cost of making it and its share of the fixed costs. |
