Business Math 08 - Understanding Profit and Loss

There are two kinds of profits. The first is a gross profit which is the total of a sale (or all sales combined) minus the cost of the goods. For example, as a store owner you buy 100 t shirts from a vendor and each shirt costs you $2.50 (unit cost). Your total cost for the t-shirts is $250.00 (also known as the cost of goods).

You then sell each individual t-shirt for $6.00. Your sale per t-shirt is the $6.00. Now you must subtract your cost of $2.50 leaving you $3.50. That $3.50 is the gross profit per t-shirt.

The second profit is the net profit. The net profit is the gross profit minus the costs of operating the business. For example, the business must pay rent for the store, electricity, heat, water and sewer, telephone, advertising, supplies (hangers, tags, etc.), insurance, a security system and salaries (operating costs). These costs (also known as overhead costs) equal 30% of the sale’s price. This gives you $6.00 x .3 = $1.80. The gross profit was $3.50 per t-shirt (or per unit cost). Now you must subtract the operating cost of $1.80 so $3.50 - $1.80 = $1.70. $1.70 is the net profit.

Not all goods will be sold for a profit. If customers will not buy a product at a certain cost, the store owner is forced to lower the price. If the reduction of the sale’s price is set too low, the sale’s price will result in the store owner taking a loss (known as a net loss). A net loss is the difference between the gross profit and the operating expenses when the operating expenses are greater than the gross profit. For example, let’s say that the store owner could not sell the t-shirts for $6.00 each but had to sell them for $4.00. You then take the sale’s price $4.00 minus the unit cost of $2.50 leaving you $1.50 gross profit. Now you must subtract your operating expenses from the gross profit or $1.50 - $1.80 = -$0.30. The store owner would be losing 30 cents per t-shirt or experience a net loss of 30 cents per unit.

Another important part of having a successful business is to always maintain a positive flow of inventory. The inventory is the total number of products, per goods, that is available for sale. For example, the store owner above purchased 100 t-shirts. The inventory for that product, i.e., t-shirts was 100. If 46 t-shirts were sold, the inventory on the t-shirts would then be 100 - 46 = 54 or 54 t shirts. Perhaps the store owner also had 200 pairs of pants, and 300 pairs of socks, 150 jackets, 300 dresses and 350 shirts. The total inventory would be 1,400 pieces or units before any sales.

If at the end of a work day the store sold 28 t-shirts and 12 pair of pants (at $24 per pants), the store would have taken in 28 x $6.00 = $168 for the t-shirts and 12 x $24.00 = $288 for the pants giving you $168 + $288 = $456. The $456 is the total sales taken in. Remember, this is not the store’s net profit and could result in a net loss.

Understanding profit and loss can help you in many areas in your life beyond just understanding how stores operate. It can especially help you in being able to run a household, sell or buy a house and sell or buy a car. It can even help you in determining the course of your future college education.

Now let’s see what you can remember about profit and loss. Look at each of the following ten questions and, without looking back at this introduction, see how many you can find the correct answer to.