“Life is a math equation. In order to gain the most, you have to know how to convert negatives into positives.” -Anonymous.
Do the math, financial knowledge times execution and organization equals small business success. We’ gathered some vital financial terms and accounting formulas every small business owner should know to help you with the knowledge part, the rest is up to you.
Revenue vs profit. What’s the difference between profit and revenue?
Before we dig into some accounting formulas for small business success. Let’s leave the answers to these vital questions on the table: What exactly is gross revenue? What’s the difference between profit and revenue?
The total amount of income your company acquires from selling goods or services is called gross revenue. On the other hand, profit is the difference between your sales and all your small business expenses, including investments, operating costs, and additional income streams.
The main difference between profit and revenue is that your gross revenue sits at the top of your income statement. On the other hand, to get your total net profit, you must deduct your key expenses. So, while revenue and profit both refer to money a company earns, it's possible for your small business to generate gross revenue and at the same time have net loss.
Here are some profit variations that can be used to measure the performance of your small business:
Gross profit = Revenue – Costs of goods sold (COGS). COGS can include the cost of the material and the direct labor used in creating the product your small business offers.
Operating profit = Gross Profit – Fixed and Variable Expenses associated with operating your small business (rent, utilities and payroll) excluding the deduction of interest and taxes.
The Break-Even Point Formula
If you want to know just how much revenue your small business must earn to cover all expenses during a specific period, then the Break-Even Point Formula is the way to go.
The formula is: Fixed Costs / (Sales Price – Variable Cost Per Unit) = Break-Even Volume.
Useful term definitions:
“Fixed Costs” are the normal, expected costs of running a business (anything from rent to salaries).
“Sales Price” is the price at which you sell your goods or the amount you charge for your services.
“Variable Cost Per Unit” is the amount you must spend to make your product or provide a service.
Applying the Break-Even point formula: Sarah runs a food stand in Miami that specializes in Cuban Sandwiches. She has one employee who earns a salary of $40,000 in a year and must pay $250 each month for insurance. Taking in consideration the sandwich ingredients and labor, it costs Sarah $2.75 to make one Cuban Sandwich, which she sells at $6.30.
So… let’s do the math!
1. First let’s measure our Fixed Costs: (($40,000/12) + $250)
2. Subtract our Sales Price from our Variable Cost per Unit: ($6.30– $2.75)
3. And divide these two components: (($40,000/12) + $250) / ($6.30 – $2.75)
4. Our Break-Even Volume is: $3,583 / $3.55 = 1,009
Which means…. (drum-rolls please!) That Sarah must make and sell at least 1,009 Cuban Sandwiches each month to cover her costs.
What is your Profit Margin? And why is it beneficial when measuring your business performance.
Along with your Break-Even Point, your profit margin is another key small business performance indicator. Use the profit margin formula to give you a hand when it comes to deciding the price of your small business’s goods or services and increase earnings or improve covering the costs of your small business’s expenses, such as manufacturing or shipping.
The formula for Profit Margin is: Net Income / Sales = Profit Margin
“Net Income”: the amount your small business has earned – its expenses
“Sales”: the balance of every sale made.
Applying the Profit Margin formula:
Michael is working on calculating the total profit margin for his fitness equipment store at the end of the year. He brought in $600,000 but had to pay a total of $30,000 in rent, $17,000 for insurance and $50,000 in salaries for his two part-time employees.
Let’s get to the fun math, again!
1. First, we figure out Michael’s Net Income: $600,000 - $30,000 - $17,000 -$50,000 = 503,000
2. Then, we divide that by his Sales $503,000 / $600,000
3. His Profit Margin = 5.2%
Measure other components when it comes to getting a good feel of your business’s financial health
Quickly identifying the key differences between revenue and profit and applying these formulas is crucial if you want to establish a solid foundation for evaluating your small business financial health. But in order to have a wholesome perspective of where your business is heading, so make sure you measure your small business health with other evaluations, such as Key Performance Indicators, Customer Reviews and most importantly- periodic meetings with your accountant or a trusted financial expert.
Disclaimer: The content of this article is based on the author’s opinions and recommendations alone. This material has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. We suggest consulting with your tax, legal, and accounting advisor before engaging in any transaction.
Team, The Investopedia. “Gross Revenue vs. Net Revenue Reporting: What's the Difference?” Investopedia, Investopedia, 9 June 2021, www.investopedia.com/ask/answers/102714/what-are-difference-between-gross-revenue-reporting-and-net-revenue-reporting.asp.
Grigg, Billie Anne. “The 6 Most Important Accounting Formulas You'll Ever Need to Know.” NerdWallet, Nerdwallet, www.nerdwallet.com/article/small-business/best-accounting-formulas-for-small-business