Starting up

Profit 101: Understanding the true meaning of profit

3 min read

Cash profit is the lifeblood of your business and is the primary factor keeping your enterprise afloat. But it’s often overlooked when the business expands and costs increase. Some businesses don’t uncover their true profit until it’s time to file their tax return with Inland Revenue. It’s better to be on top of your profit situation before it’s time to file – making it much easier to budget for expansion, pay bills, and price your products and services.

How net profit is calculated

Net profit is simply the amount of cash remaining in your business after all operating expenses are deducted (including all interest and taxes). Net profit can be a bit confusing, as it’s also known as your ‘bottom line’, ‘net income’, or ‘net earnings.’

Regardless, it’s always calculated the same way:

Total Revenue – Total Expenses = Net Profit

To calculate your own net profit, you’ll need to have a few important financial figures on hand, such as your total expenses and sales revenue. If you’ve been using a cash flow forecast, this information will be easy to find. If you don’t know where to start or need a bit of extra help, now’s a good time to get in touch with your BNZ Business Specialist or your accountant.

Sales don’t always equal profit

Unfortunately, sales don’t translate into profit. If you’re new to business, it’s easy to confuse sales with profit but they’re a very different beast. It’s possible to have products flying out the door as fast as you can sell them, but still struggle to turn a profit. It sounds odd, but many businesses have gone bust when they’re at their busiest.

Your profit is always what’s left after all your costs have been deducted from sales. If you make a mistake (even a modest one) when setting your prices, your business might appear to be thriving when it’s really operating at a loss, or with the tiniest profit margin. It does happen.

Identifying and monitoring your fixed and variable costs will ensure you’re making money and staying afloat. It’s easy once you know what you’re looking for.

Variable costs

These are the direct costs of production that vary with sales levels. Variable costs can include the cost of raw materials or stock, or the labour cost of delivering a product or service.

Fixed costs (overheads)

Regardless of how many items you sell each month, you’ll have some fixed costs to pay such as a lease or mortgage, a vehicle, or office costs. You need to include these costs, or at least a percentage of them, in your pricing.

It’s a smart idea to keep an eye on your fixed costs as a percentage of total sales. For example, if it costs you $20,000 to run your café each year, and your annual sales are $200,000, your fixed expenses represent 10% of sales.

If you can increase your sales next year to $300,000 but still keep your expenses at $20,000, your fixed expenses will now be only 6.67% of sales.

Protecting your hard-earned profit

Some business owners consider their surplus profit as the amount they can safely pay themselves as a salary. But profit is more useful than just providing a salary – it enables you to earn interest and have money on hand to take advantage of growth opportunities.

Your salary should be part of your overall business expenses, so profit more accurately becomes any surplus money left over after you’ve taken your salary and paid all other costs (including tax). This is really important because you need to have enough in your accounts to cover all expenses.

If you’re a start-up business, it’ll take time to reach your break-even point and start making a profit. During this time you may not be able to draw much money from the business. Keeping some funds in the bank during this period will reduce stress and keep your business ticking along.

In the medium to long term, you need to aim for a salary that’s generally in line with what you could earn elsewhere as an employee – and preferably better. Otherwise, you’d be better off working elsewhere.

Using a business savings account

Depositing your profit into a business savings account, such as a Business First OnCall account, makes it easier to provision for tax payments and gives you the flexibility to make big-ticket purchases when you need to. With a BNZ Business First OnCall account, you'll earn competitive interest, which is calculated daily and paid monthly. To make it even better, there aren’t any transaction or monthly base fees for you to worry about.

If you use more than one business account, you could look in to a TotalMoney for Business account. TotalMoney for Business is a unique way of banking that lets you group separate bank accounts through pooling, to potentially earn a higher interest rate for all the accounts.

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