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Learn the key concepts for building and managing a profitable business. Understand your sales and costs, and how to find your break-even point
Find related content on this topic—read about how to grow your profit.
Making a profit video
In this video an example situation is used to illustrate how to calculate profit.
This video covers:
- profit, loss and breaking-even
- calculating gross profit margins
- reducing expenses.
Transcript of video
Profit basics
Every business aims to make a profit. In simple terms, your business's profit (or loss) is the difference between your income and your expenses.
Formula: Profit = Income - Expenses
Remember that profit is not the same as the amount of cash you have in the bank or your total sales. Profit is the total financial gain you make from sales (on paper) after all expenses are paid.
Depending on the type of business you run, your income will usually come from sales to customers (i.e. your turnover).
The profit you make will depend on your business expenses. Keep track of all expenses to make sure you're maximising your business's profits. Making a profit means your business can continue to operate successfully and will be in a good position to grow.
Expenses and costs
Expenses reduce the amount of profit your business makes. Review your expenses regularly and look for ways to reduce what you spend.
Separate expenses into categories to help you calculate and monitor your costs. This can also help to identify where costs are rising, or what can be reduced.
You can break expenses down into the following categories:
Fixed expenses stay the same no matter how many items you produce or how many sales you make. They may include:
- rent
- maintenance costs for your workplace
- insurance and accounting
- licence fees
- utilities (e.g. electricity, water, internet)
- depreciation.
Variable expenses go up or down based on the number of items you produce or sales you make. They may include:
- labour costs
- costs of raw materials
- advertising
- packaging
- freight or delivery charges
- electricity.
Utilities are usually fixed expenses, but costs may vary as you increase production and sales (e.g. running more equipment for longer periods).
Cost of goods sold (COGS) are the business costs that relate directly to sales. These may include:
- the stock and materials from suppliers you need to produce your goods and services
- freight and delivery costs for getting supplies to your business.
The figures you use to calculate your COGS can vary across industry and business types. Check with your accountant or business adviser for detailed advice on determining COGS for your business.
As a business owner you may choose to pay yourself an income or salary. This should be equal to what you would pay an employee to do the same work and include superannuation.
Consider your personal and business needs before making a decision on your income or salary. You may need to balance your need for a steady income against making an investment into your business.
There may be tax implications to consider from your decision. Talk to your accountant or business adviser for more advice. Remember to include your wages or salary as drawings in your chart of accounts, if you have one.
Sales and turnover
To make a profit, you must understand what minimum level of sales (also known as revenue or turnover) you need to cover your operating expenses, and to make enough money for your personal commitments.
Turnover
Turnover = Number of customers × Average number of transactions per customer × Average value of each transaction
Your turnover can also be calculated by multiplying your volume of sales by the price you sell your goods or services for.
For example, if you sell 100items for $10 each, your turnover is $1,000.
Understand your gross profit margin to determine which products you need to sell more of.
Generally, the higher your gross profit margin and selling price, the lower the volume of sales required (and vice-versa).
Income from sales will go into covering your variable costs (materials and direct labour) and fixed costs (overheads). Any income leftover will be your profit and contribute towards your profit goal.
The sales price of your goods or services is a key factor in calculating your turnover. Find out about pricing products and services.
Break-even point
You need to know what your break-even point is to build a profitable business. This is the point where your total revenue (sales or turnover) equals total costs. At this point there is no profit or loss—in other words, you 'break even'.
Knowing your break-even point can help you make a decision about your selling prices, set a sales budget and prepare your business plan.
Your business could turn over a lot of money, but still operate at a loss. Identifying your break-even point will help you to work out:
- your profitable product lines
- how far sales can decline before you start to make a loss
- the number of units you need to sell before you make a profit
- if reducing price or volume of sales will impact your profit
- how much of an increase in price or volume of sales you will need to make up for an increase in fixed costs.
You can also understand critical profit drivers of your business including:
- number of sales
- average production costs
- average sales price.
A simple way to calculate your break-even point is using your fixed costs and gross profit margin.
Use our interactive calculator to work out your break-even point.
Calculate break-even point
$$\text{Break-even point} = \frac{\text{Fixed costs}}{\text{Gross profit margin}}$$
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Your break-even point is:
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This is a simplified formula. Talk to your accountant, bookkeeper or tax agent when planning.
Break-even and minimum sales template
Use our break-even and minimum sales downloadable template to calculate these key figures for your business using your sales and costs data.
This worksheet provides examples and calculations to work out your break-even point and the minimum sales your business needs to make to cover expenses and make a profit.
Profit margins and drivers
Understand the basics of profit, including profit margins and profit drivers, to help you develop strategies to increase your profits.
Gross profit and gross profit margin
Gross profit is the money your business holds after deducting the cost of making and selling your product.
Formula: Gross profit = Total revenue - Costs of goods sold
When your sales revenue (the total amount you bring in from sales) exceeds your direct expenses (cost of goods sold), your business has made a gross profit. Gross profit is a valuable measure of whether your pricing policy, volume of sales and cost of goods sold will make your business a profit.
Calculate gross profit
$$\text{Gross profit} = \text{Total revenue} - \text{Cost of goods sold}$$
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Gross profit margin uses your gross profit to show your business's overall health. To show your gross profit figure as a profit margin, calculate:
Formula: Gross profit margin = Gross profit ÷ Total revenue × 100
Gross profit margins are always displayed as a percentage figure, never whole numbers.
Note: Gross margin is not commonly used for service businesses as cost of goods is not a major consideration.
Gross profit per unit can also be called contribution margin.
Calculate gross profit margin
$$\text{Gross profit margin} = \frac{\text{Gross profit}}{\text{Total revenue}} \times 100$$
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Show calculatorGross profit margin example
Brett's Bakery has a total revenue of $450,000, which after subtracting the $300,000 costs of its raw materials (flour, eggs, sugar etc.) and wages directly involved in baking and selling the goods, leaves a gross profit of $150,000. Based on these sales and costs, Brett's Bakery has a gross profit margin of 33%.
Net profit and net profit margin
To calculate net profit, deduct all business operating expenses from gross profit, such as wages, supplies and materials, rent, utilities, advertising costs, taxes, interest and one-off costs.
Formula: Net profit = Gross profit - Operating expenses (your business's overall costs, not just those of a product)
Calculate net profit
$$\text{Net profit} = \text{Total revenue} - (\text{Cost of goods sold} + \text{Operating expenses})$$
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Your net profit is:
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Show calculatorNet profit margin is your gross profit margin less your business overhead expenses. It's your profit before you pay tax. Tax isn't included because tax rates and tax liabilities vary from business to business.
Net profit margin can be expressed as a percentage value or as a dollar value (called net profit). Use our interactive calculator to work out your net profit margin.
Calculate net profit margin
$$\text{Net profit margin} = \frac{\text{Net profit}}{\text{Total revenue}} \times 100$$
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Your net profit margin is:
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Show calculatorNet profit margin example
Brett's Bakery has a total revenue of $450,000, which after subtracting its $405,000 total operating expenses, leaves a net profit of $45,000. Based on these sales and costs, Brett's Bakery has a net profit margin of 10%.
Using profit margin data
Compare your gross and net profit margin data with other businesses in your industry. You can then work out where you need to improve your operations to keep up with the competition. You can also spot profitability trends that show you where other businesses are catching up.
Check the profit margin of specific products you offer, rather than just having an overall picture of your business's profit margin. This will help you judge if you should stop producing certain items—because they are not profitable—or concentrate production and marketing efforts to improve a certain product's profitability.
This is an example contribution margin (gross profit per unit) for a bakery that sells sweet rolls, savoury rolls and bread loaves.
This is useful to help you understand what your most profitable and least profitable products are, and decide which products you should keep or stop selling.
Product | Costtomake | Saleprice | Grossprofit | Grossprofit margin |
|---|---|---|---|---|
Sweet rolls | $0.50 | $2.00 | $1.50 | 75% |
Bread loaves | $1.00 | $3.00 | $2.00 | 66% |
Savoury rolls | $1.50 | $2.00 | $0.50 | 25% |
If the bakery sold 106sweet rolls, 180loaves of bread, and 100savoury rolls a day, the gross profits would be:
Product | Dailytarget | Grossprofit | Grossprofit margin | Dailygross profits |
|---|---|---|---|---|
Sweet rolls | 106 | $1.50 | 75% | $159 |
Bread loaves | 180 | $2.00 | 66% | $360 |
Savoury rolls | 100 | $0.50 | 25% | $50 |
Totals | 386 | $569 |
Setting a profit goal
A profit goal will help you make decisions around your business finances. Your profit goal is the amount of money you need to meet the commitments that are important to both you and to the future of your business.
Talk with your accountant, bookkeeper or tax agent to help set a profit goal for your business.
To set a profit goal you must understand your business and what you can realistically achieve. Consider your costs, as well as your return on capital, return for risk and return for future growth when setting your goal.
Return on equity is a useful indicator for how successfully your business uses its investments to generate an adequate return and make a profit. Return on equity is often shown as a ratio (e.g. for every dollar you invest, you generate $1.50 in return).
Your return on equity should be at least equal to long term bank interest rates (for borrowed money) as well as an additional return based on the level of risk.
Calculate return on equity
$$\text{Return on equity} = \frac{\text{Net profit}}{\text{Owner's equity}} \times 100$$
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The minimum number of sales is the point where your business has made enough money to cover expenses and make a profit.
To work out your minimum sales requirement, calculate how much of your products or services you need to sell to cover:
- fixed costs
- your salary
- your desired profit.
Aim to achieve a fair return on the money you have invested in your business, as well as your salary. Once you've calculated your break-even point, decide what you consider to be a reasonable return on investment given the level of risk, and a suitable salary for the owner or manager of the business (this may be yourself).
It's useful to view your minimum number of sales as total number of products you need to sell on a daily or weekly basis. If your business can't generate the minimum number of sales, then you won't meet your profit goal.
Use our break-even and minimum sales template or interactive calculator to work out your minimum sales requirement.
Calculate minimum sales requirement
$$\text{Minimum sales requirement} = \frac{\text{Fixed costs} + \text{Profit goal}}{\text{Gross profit margin}}$$
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Your minimum sales requirement is:
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Meet your profit goal
- Set a profit goal.
- Calculate your gross profit margin for your products to identify which products to focus on for maximum profit.
- Calculate your fixed and variable costs.
- Calculate your minimum number of sales to break even (use your turnover to help calculate this).
- Calculate your total number of sales required to achieve your profit goal.
Also consider...
- Learn about setting sales targets and break-even points.
- Last reviewed: 20 Dec 2021
- Last updated: 13 Jan 2022
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