How is my business doing? How much tax will I owe at the end of the year? These are questions answered by knowing the business’ profitability.
Profit On Sales
The profitability of a business begins with Profit On Sales. This is a major player in answering the questions above but not the only one. So what is Profit On Sales? The basic calculation is what the product is sold for – what you paid for it = profit on sales. Lets say the business sells five items.
- Item 1 costs $5.00 and sells for $10.00. Profit of $5.00 or 100%
- Item 2 costs $3.00 and sells for $9.00. Profit of $6.00 or 200%
- Item 3 costs $15.00 and sells for $25.00. Profit of $10.00 or 66%
- Item 4 costs $12.50 and sells for $25.00. Profit of $12.50 or 100%
- Item 5 costs $22.50 and sells for $35.00. Profit of $7.50 or 33%.
Which items have the higher profit margin? Which ones would you like to sell more? Now lets say there is on hand inventory for the items above.
- Item 1 quantity 10 total cost of $50.00 sells for $100.00 potential profit of $50.00
- Item 2 quantity 20 total cost of $60.00 sells for $180.00 potential profit of $120.00
- Item 3 quantity 5 total cost of $75.00 sells for $125.00 potential profit of $50.00
- Item 4 quantity 5 total cost of $62.50 sells for $125.00 potential profit of $62.50
- Item 5 quantity 10 total cost of $225.00 sells for $350.00 potential profit of $75.00
Profit is only realize when the item is actually sold. So at this stage it is “potential”. The current value of all on hand inventory, a tax item, is $472.50 and potential profitability is $357.50. That’s cool until the parent company adjusts cost and prices. Here are the new values. (Hang in there I have a point.)
- Item 1 costs $4.00 and sells for $8.00. Profit of $4.00 or 100%
- Item 2 costs $2.50 and sells for $7.50. Profit of $5.00 or 200%
- Item 3 costs $20.00 and sells for $30.00. Profit of $10.00 or 50%
- Item 4 costs $15.00 and sells for $25.00. Profit of $10.00 or 66%
- Item 5 costs $20.00 and sells for $30.00. Profit of $10.00 or 50%.
The change seems to be a non-issue or maybe a benefit. But look at the business’ on hand inventory value and “potential” profit. Remember Profit is the difference of what you sell a product for minus what it cost you. So…
- Item 1 quantity 10 total cost of $40.00 sells for $80.00 potential profit of $40.00
- Item 2 quantity 20 total cost of $50.00 sells for $150.00 potential profit of $100.00
- Item 3 quantity 5 total cost of $100.00 sells for $150.00 potential profit of $50.00
- Item 4 quantity 5 total cost of $75.00 sells for $125.00 potential profit of $50.00
- Item 5 quantity 10 total cost of $200.00 sells for $300.00 potential profit of $100.00
The current value of all on hand inventory is still $465.00 based on the new cost and potential profitability is $340. Right? Wrong! The value of the on hand inventory didn’t change because the cost to you changed. It is already on hand. Therefore, The current value of on hand inventory is still $472.50. What changed is the potential profit.
- Item 1 quantity 10 total cost of $50.00 sells for $80.00 potential profit of $30.00
- Item 2 quantity 20 total cost of $60.00 sells for $150.00 potential profit of $90.00
- Item 3 quantity 5 total cost of $75.00 sells for $150.00 potential profit of $75.00
- Item 4 quantity 5 total cost of $62.50 sells for $125.00 potential profit of $62.50
- Item 5 quantity 10 total cost of $225.00 sells for $300.00 potential profit of $75.00
So, potential profit that was $357.50 is now 332.50. Not a big difference but imagine if the business had many more inventory items. If these items sold in the current tax year at the new book price, the business could be paying more tax than necessary and you would think you are more profitable than reality.
It’s A Party (IAP) handles this situation. Given that inventory is maintained regularly, IAP will know what the cost was of each item purchased even if the on-hand inventory was purchased at an old cost. Imagine the paper shuffling necessary to keep track of this without a computer and a good application.
Another situation: consider there is no cost/price change from the company but the company has a special deal for 3 days, say the item cost half as much. Items currently in inventory cost $20.00. However, during the three-day sale they cost $10. The business has the funds so you you buy 30. These would cost you $300.00 instead of $600.00. Since the selling price to your customer did not change, the business has much higher profit on these items. Wouldn’t you like to be able to reflect that when you check how your business is doing?
Total Profit
Actual profitability of the business must take into account other expenses such as supplies, mileage, meals, etc… These expenses can be tracked in It’s A Party and reported to give you a picture of your business’ true profitability.