The existence and continuity of every business relies heavily on how well a person or company sells their products and/or services — and also how good they manage and minimize business expenses. These two factors cause the business either to earn profit or incur losses.
It’s a common mistake to think that the business is earning money if there is a sale. However, the real test of good business performance lies on business income.
To determine if the business is profiting or losing money, you need to learn how to compute your business income.
Most businesses leave the job of computing their business income to their accountants. It is a practical move because accountants are technically competent to do the job. However, it is crucial that a businessperson understand the factors in computing business income so that they can better interpret and manage the financial result of the business operation. Furthermore, it can help the business determine which product or service is earning or incurring losses. As such, they can decide which product or service they should continue to sell and which to stop selling.
In this article, I hope to share with you my knowledge in accounting to help you better manage your own business finances. You will discover tools that will help you to compute your business income and learn the factors which can help you interpret the numbers shown in an income report.
Business Income Computation
Generally, business income is computed as follows:
Business Income = Revenue – Expense
Business income is the amount of gain (in monetary value or in kind) earned from a sale of a service and/or product after deducting all incidental expenses incurred by the business.
Revenue is the amount of money received (or to be received) in exchange for the product and/or services provided and sold. Revenue includes gross receipts on sale of service — or gross sales on sale of product. For each sale of a product or service, the amount of revenue increases. Meanwhile, sales discounts and allowances given to buyers or customers for bulk orders or special promos decrease the amount of revenue. Sample sales of products includes the sale of grocery items, bags, shoes, clothes, software, electronic gadgets, books, etc. On the other hand, the sale of a service includes service fees earned from transportation, communication and sale of professional skills like freelance writing, virtual assisting, accounting, legal advice, doctor, etc.
Expense is the amount of money paid (or to be paid) in exchange for product and/or service received and purchased. Sample expenses include inventory purchases, salary and wages, transportation, advertising, electric and water bills, communication, professional fees, etc.
3 Easy Steps in Computing Business Income
- Identify all the products and/or services sold in a given period and then total the amount. The total represents your revenue.
- Identify all the costs you pay in order to operate your business in the same given period. The total represents your total expenses.
- To compute your business income, subtract your total expenses against your total revenue.
Sample Illustration and Computation
John Doe is a software developer who owns a Software Company which focuses on developing and selling online software. Additionally, he has a number of blogs that promotes other people’s products and in return, he earns commission income. (Note that the period we want to compute is for the whole year of 2011.)
Step 1 – During 2011, Joe’s revenue was as follows:
Sale of Software $200,000
Commission on sales of other people’s product 40,000
Total Revenue $240,000
Step 2 – The cost in operating Joe’s Software Company during 2011 includes the following:
Web Hosting Expenses $2,400
Domain Fees 10
Salaries Paid 60,000
Rental and Utilities Expenses 10,000
Total Expenses $72,410
Step 3 – Joe’s business income in 2011 is $167590, computed as follows:
Business Income = Total Revenue – Total Expenses
= $240,000 – $72,410
Based on computed business income for 2011, Joe’s Software Company is showing a good performance since the total revenue is greater than the total expenses.
Conclusion – Interpreting Business Income
1. If Revenue > Expense = Income/Profit.
When the amount of revenue earned is greater than the expenses incurred, it can mean the business operation is doing well because there is enough amount of money to pay all the business expenses. Also, it is an indicator of good business management.
2. If Revenue < Expense = Loss.
When the amount of expenses spent is greater than the revenue earned, it signals poor business performance since the amount received in selling products and/or services is not enough to pay all the expenses necessary to operate the business. Furthermore, this may indicate poor business management.
3. If Revenue = Expense, we call it “Break-Even Point”.
When the business revenue is equal to the expense, we call it break-even point. This indicates that the business is neither earning nor incurring loses. The earning is just exactly enough to pay the business operating expenses. It can still show poor business performance and management since the objective of a business is to earn profit.
(Photo credit: Accounting via Shutterstock)