Computation of Gross

Profit
 Compute for profits

Define profitability, liquidity &

solvency

Identify commonly used

profitability ratios.

OBJECTIVES
 As we all know that profit is a financial gain from a transaction or from a period of investment or business activity, usually
calculated as income in excess of costs or as the final value of an asset in excess of its initial value.

It is a total revenue minus total expenses, profit is the amount of money a business "makes" during a given accounting period. The
more profit you make, the better, as profit can be re-invested into the business or retained by the business owners. Being able to accurately
determine your business's profit is an essential part of being able to judge its financial health. It can also help you decide how to price your
goods and services, how to pay your employees, and more.

To make your business gain more profit, begin by adding up all of the money your business has made in a set period of time (either,
quarterly, yearly, monthly, etc. Other sources, like products sold, services rendered, membership payments, or, in the case of government
agencies, taxes, fees, the sales of resource rights, and so on.

Note that you will need to subtract any amount of cash refunded to customers for returns or disputes in order to find an accurate
figure for your total income. It's easier to understand the process of calculating a business's profit by following along with an example.

Let's say that we own a small publishing business. In the last month, we sold P20,000 worth of books to retailers in the area.
However, we also sold the rights to one of our intellectual properties for P7,000 and received P3,000 from book retailers for official
promotional materials. If these represent all of our revenue sources, we can say that our total income is P20,000 + P7,000 + P3,000 =
P30,000.
 Computation of Gross Profit

Let’s review of what is revenue of the business. This is an important tool and materials needed
in the operation of the business. It is said that revenue is the result when sales exceed the cost to
produce or manufacture goods/merchandise as well as costs incurred in selling.

Forecast is advance information that could help us prepare and ready for any incoming event.
Forecasting is the tool used in planning that aims to support management or a business owner in its
desire to adjust and cope up with
uncertainties of the future. If anyone of us can predict that we can be rich so it means all of us will
be rich. This fantasy is played out every day in boardrooms across the globe with the practice of
business forecasting.

It is important to have a good organization in the business to easily grow and expand in the
future.
 Rodrigo is engaged in a buy-and sell business of perfumes. He bought 10 boxes
of perfumes. Each box costs 12,000.00 and contains a dozen of perfume bottles. He
is planning to sell one perfume bottle at P1,500. What is his expected profit on the
10 boxes of perfumes? The ultimate goal of any business whether a retail or
wholesale is to earn a profit. Getting the difference between the amount of money
earned from the selling 10 boxes containing a dozen of perfume bottles and the cost
of those 10 boxes gives the profit.

How much does Rodrigo earn profit?

 Compute the Gross Profit
The profitability ratios are a group of financial statement that primarily determine the
profitability of the business operation.
The gross profit on a product is computed as:
Net Sales xxxxxxx
Less: Cost of sales - xxxxxxx
Gross profit xxxxxxx

By using the formula, the gross of XYZ Trading in the year 2017
Net Sales P 734, 000.00
Less: Cost of Sales - P 577, 000.00
Gross Profit P 157, 000.00
Profit is the gross income. The amount of gross profit provides information to the entrepreneur about
revenue earned from sales.

The term cost refers to the purchase price of the product including of the product including the total outlay
required in producing it.
The gross profit margin is computed as follows:

gross profit rate =

The gross profit rate measures the percentage of gross profit to sales, indicating the profit that the business
realizes from the sale of the product.

The gross profit rate of XYZ Trading for the year computed as follows:
gross profit rate =
gross profit rate = 21.39%

The gross profit rate may signal to the entrepreneur that the amount of margin on sales is 21.39%. This rate will be used
to determine whether the amount of gross profit can cover the operating of the business. Since the gross profit rate of
XYZ Trading is 21.39%, the cost ratio to sales will be 78.61%. This information will help the entrepreneur in assessing
whether the cost is too high or too low. Any product with a very high cost will not become competitive in the market. The
gross profit rate will also help the entrepreneur set the selling price.
 Operating Profit Margin

The operating profit margin is the excess of gross profit from operating expenses.
Gross profit xxxxx
Less: Operating Expenses - xxxxx
Operating profit Margin xxxxx

The operating profit margin is the second level of revenue in the income statement. At
this stage, not only the cost of buying or making the product that has been deducted is included
but also the operating expenses. These are expenses incurred during a particular period only, and
are not expected to provide benefits to any future period. The operating expenses are also period
costs.
 Operating Profit Margin

In case there are no financing charges like interest, expenses, and income tax, the amount of the operating
profit margin is equal to the net income.
Gross profit P 157,000.00
Less: Operating Expenses - P 90,000.00
Operating profit Margin P 67,000.00

This information that the business realized an income of P 67,000.00 during the year after deducting the
cost and operating expenses from the sales made.
Operating Profit Margin Rate
Operating profit margin rate =
Operating profit margin rate =
Operating profit margin rate = 9.13%
The operating profit margin of the business measures the percentage of profit available after deducting the cost of sales
& operating expenses of the business. A higher operating profit margin is favorable to the business.
 Net Profit Margin

Operating profit margin xxxxxx

Add: Interest Income xxxxxx
Total
Less: Interest expense xxxxx
Income Tax xxxxx xxxxxx
Net Profit Margin xxxxxx

The Income statement is the net profit margin & the third level in the revenue. The business is only given
consideration like interest expense and income tax.

The Income statement.is the net profit margin & the third level in the revenue. The business is only given
consideration like interest expense and income tax.
Operating profit margin P67,000.00
Less: Income tax P20,000.00
Net profit margin P46,900.00
 The income statement of XYZ Trading does not reflect any data on interest expense. Only
income tax has been deducted from the operating profit margin.
Net Profit margin rate =
By applying the formula, the profit margin of XYZ
Net Profit margin rate =
Net Profit margin rate = 6.39%

XYZ Trading appears to have earned 6.39% of its total sales of P734,000 during the year. This
profits rate must be compared with those of other similar businesses within the industry.
 Analyse the Liquidity Status of the Business

Liquidity Ratios
Current ratio = Current assets / Current liabilities
Quick ratio = (Current assets – Inventories) / Current liabilities
= (Cash and equivalents + Marketable securities + Accounts receivable) / Current liabilities

The quick ratio measures its short-term obligations with its most liquid assets and therefore excludes
inventories from its current assets.

Financial statements are important in a company management as a means of communicating past successes
as well as future expectations. The financial statement records all the operating results such as sales, expenses
and profits or losses.
 Return of Investment (ROI)

The Return of investment (ROI) measures the amount of

net income per peso Invested to the business.
The formula to compute ROI is as follows:
Return of Investment =
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Yearly increase in revenue is assumed at 5%
Yearly increase in cost is assumed at 5%

As a future entreprenuer, one should always remember that nothing is permanent in the field of
entreprenuership. What is applicable to one entreprenuer may not be applicable to another. Certain things may
happen to one entrepreneur but may not happen to another.

Entreprenuership should be practiced not as a science but as an art. Creativity should always be applied to
entrepreneur by regularly evaluating the market and the environment and responding to the changes in them.

The owner of an ordinary small business has the freedom to manage and operate. Ideally he/she prefers
business activities which are done easily. However, the entrepreneur has to perform the entrepreneurial
activities correctly regardless of whether they are undertaken easily or not. The important in entrepreneurship is
thatthe business activities are performed correctly.
What Have I learned?
The profitability and ratios are a group financial statement ratios that primarily determine the profitabilty
of the business operation. They provide information on the efficiency of resource utilization.

The gross profit represents the difference between net sales and cost of salesof the entrepreneurial venture
during a given period. It is computed as follows:
Net Sales xxxxxx
Less: Cost of Sales xxxxxx
Gross Profit xxxxxx

Profit is determined by:

• the money you get from sales
• the cost of stock – if you're selling a product
• all the expenses you incurred
Income earned by the business are sales & gross profit. Commissions,discounts , fixed expense are
business expenses.
How to Increase your Sales
❖ Improve profit by looking at the money you earn from sales, and increase:
o The number of customers
o The volume of goods or services existing customers to buy
o The sales price