The definition of trading profits is the profit made by a small business buying and selling goods or services – and it does not take into account any finance charges, interest, tax or sale of a company’s assets. It is sometimes called operational profits since it measures the success of the core part of the business and so the measure of trading profits is a great indicator as to the health of a business.
There are other types of business profit, such as Gross Profit, Net Profit and Earnings or EBITA.
In this article we describe how to calculate trading profits and the alternative profit measures you might encounter running your company.
Do not be afraid.
In today’s article, we will discuss how to precisely calculate trading profits by going over several key factors related to understanding those profits.
Operations & Trading Profits
“Trading profit” is synonymous with “profit from operations” as it does not include any income or expenses related to financing, nor does it have any profits or losses resulting from the sale of assets.
This is a good indicator of how capable the core operations of a business are of generating a profit for the company.
A plumber has sales of £40,000 in a year. He also spends £2,000 on parts, £1,000 on petrol, and £4,000 on advertising.
The trading profit is £40,000 – £2,000 – £1,000 – £4,000 = £33,000
A gift shop has sales of £40,000 in a year. The shop has money in a high-interest account that has earned £1,000 over the last year. It has also sold the company van for £4,000. It bought stock for £15,000 and paid staff £20,000.
In this example, to calculate the trading profit we ignore the interest gain and the money from the sale of the asset (the van) and so the trading profit is £40,000 – £15,000 – £20,000 = £5,000
The gross profit is calculated by taking the total sales revenue and subtracting the costs of making or buying the goods or services you have sold. These costs are often called the Cost of Goods Sold (COGS).
Gross Profit is a clear measure of how efficiently your business uses staff and supplies to create new products or services it then sells to customers. It is a key measure of the financial performance of your business and can help you understand if you are spending too much on buying new supplies or on staff to manufacture or provide services. If you can reduce your COGS, your Gross Profit increases and you will generate more money to support the operational side of your business which is measured through Net Profit.
Net Profit is measured by taking the Gross Profit and subtracting the operating costs of the business. These operating costs are not essential to make or provide the services, but are essential to run the business.
For example, operating costs will include your accountancy fees, your bank charges, taxes, interest, advertising costs, etc.
Net Profit is a great measure of the overall health of your business and allows you (or any investors) to see how your business is doing. This compares to Gross Profit which is a measure of how efficiently the business can produce or sell goods and service; Net Profit is a measure that takes into account all the costs of running the business.