In the modern competitive business environment, most of the organizations are focusing on increasing their ROI (Return On Investment) by reducing their risks. That means their main objectives are to gain more profits compared to their competitors. Therefore, accounting profit can be identified as a key factor that the stakeholders are always keen about. The management, shareholders and other interested parties tend to make important decisions based on this figure in the financial statements. Financial institutions and the government also concerning about it when lending money for the business expansions and to increase the market share. Investors may be concerned about it, in order to identify the financial stability of the company within the industry. Likewise, accounting profit has been used by many parties to make evaluations regarding the current position of the company. Therefore, in this article, we will learn how to calculate accounting profit in the financial statements. Following sections have been used to explain the methods that are necessary to calculate accounting profit.
How to Calculate Accounting Profit?
To calculate accounting profit, deduct all the explicit costs from the sales revenue of the company. It has a direct relationship with the net income on the financial statement. The accounting profit is calculated on the basis of Generally Accepted Accounting Practice (GAAP). Explicit cost comprises with operating expenses such as raw material, interest paid, utility paid, employee’s wages, etc. In some occasions, accounting profit is included in the income statement as net profit before taxes. Almost in every organization, there are primarily three financial statements created for a specific time period. i.e. Income Statement, Balance sheet and the Cash Flow Statement. The income statement or the profit and loss account is useful to identify the figures related to sales revenue and the operational expenses within a specific time period.
Calculating Accounting Profit – Example
As indicated in the below Income Statement, to calculate accounting profit (Net profit after tax), all the operating costs are deducted from its total sales revenue within a particular time period.
|Cost of Sales||(xxxx)|
|Selling & Distribution Expenses||(xxx)||(xxx)|
|Earnings before interest & tax (EBIT)||xxxx|
|Earnings before tax (EBT)||xxxx|
|Net profit after tax||xxxx|
According to the above Income Statement, accounting profit formula can be derived as below.
Gross Profit = Total sales revenue – Cost of sales
Accounting Profit= Gross Profit – (Operating Expenses + Taxes)
At the end of the financial year all the accounts are summed up and derive the total amounts. Then the Income statement is prepared using the figures in the ledger accounts. The Net profit after tax amount in the Income Statement is taken to the balance sheet in order to match the assets with the capital and liabilities of the company.