What is Operating profit – Explanation with Examples

What-is-Operating Profit

Operating Profit is that part of the revenue which is left after deducting operating cost/expenses from the Gross Profit. Operating expenses/cost include all the cost incurred on all operative activities of the business. It is also known as Earning Before Interest and Taxation (EBIT).

The Formula of Operating Profit : –

1. Base on Operating Revenue:

EBIT can be calculated from the total operating revenue with the following formula: 

Operating Profit/EBIT = Operating Revenue – COGS – Operating Expense/cost – Depreciation – amortization” 

2. Base on Gross Profit: –

EBIT can be calculated from the Gross profit with the following formula: 

“Operating Profit/EBIT = Gross  Profit – Operating Expense/cost – Depreciation – amortization” 

Examples of Calculation of EBIT

Example 1 : – 

As on 01/04/2019 A&b Co. ltd. have a stock of goods worth Rs. 35,000. The purchase goods worth Rs 1,50,000 and purchase return Rs 15,000 during the year and spent 2,000 on Carriage, 400 on loading. They sold goods for worth Rs. 5,35,000 and sale return Rs. 25,000 during the year and after that at the end of the year Rs 12,400 stock of goods left.

Other Expenses are salary 1,20,000/-, Electricity Rs. 50,000 and Depreciation of Plant and Machine Rs 10,000.

Calculate the EBIT of Mr X.

Solution: –

EBIT = Operating Revenue – COGS – Operating Expense/cost – Depreciation – amortization” 

First, calculate Cost of Goods Sold: –

COGS =  Opening Stock + Net Purchase + Direct Expenses – Closing Stock

 35000 + (150000 – 25000) + 2000 + 400 – 12400

COGS = 1,50,000/-

Operating Expenses = Salary  + Electricity
=1,20,000 + 50,000
Operating Expenses =1,70,000/-

EBIT    = (5,35,000 – 25,000) – 1,50,000 – 1,80,000
= 5,10,000 – 2,30,000
EBIT = 2,80,000/-

 

Example 2 : – 

Gross Profit of the year is Rs 18,500 and  Further Mr X paid a salary to his employees 2,500/-, shop rent 1,000 and Shop lighting 200. Now calculate the EBIT earned by Mr X.

Solution: –

EBIT = Gross Profit + Operating Cost/ Expenses

We already got Gross Profit in the question = 18,500/-

SO,  18500 – 2500 -1000 – 200

EBIT = 14,800/-

Example 3 : – 

Gross Profit of the year is Rs. 5,00,000, Further Mr Y paid a salary to his employees 92,500/-, Electricity charges Rs. 25,000 and Depreciation of Building Rs 50,000.  Now calculates the EBIT earned by Mr X.

Solution: –

EBIT = Gross Profit + Operating Cost/ Expenses

We already got Gross Profit in the question = 5,00,000/-

Operating Expenses =  Salary of Employee + Electricity Charges + Depreciation on Building 
=  92,500 + 25,000 + 50,000
= 1,67,500/-

EBIT = 5,00,000 + 50,000 – 1,67,500

EBIT = 3,82,500/-

Check out the difference between Gross and Net Profit.

Difference between Gross profit and Net Profit

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What is Net profit – Explanation with Examples

What-is-Net-Profit

Net Profit (N.P.) is that part of the revenue which is left after deducting total cost/expenses from the total revenue or indirect cost/ expense from the Gross Profit. Indirect expenses/cost include all the cost incurred on the administrative expenses, selling & distribution, financing cost and Taxation. It is also known as Earning After Interest and Taxation(EAIT)

The Formula of Net Profit : –

“Net Profit = Gross Profit + Indirect Incomes – Indirect Expense/cost” 

Example 1 : – 

Gross Profit of the year is Rs 18,5000 and  Further Mr X paid a salary to his employees 2,500/-, shop rent 1,000 and Shop lighting 200. Now calculate the Net Profit earned by Mr X.

Solution: –

Net Profit = Gross Profit + Indirect Income – Indirect Cost/ Expenses

We already got Gross Profit in the question = 18,500/-

SO,  18500 – 2500 -1000 – 200

N.P. = 14,800/-

Example 2 : – 

Gross Profit of the year is Rs. 5,00,000, Further Mr Y paid a salary to his employees 92,500/-, Electricity charges Rs. 25,000 and Depreciation of Building Rs 50,000. In addition to that, he has received the Rent from the Tenant for the let-out building Rs. 50,0000. Mr  Now calculates the N.P. earned by Mr Y.

Solution: –

N.P = Gross Profit + Indirect Income – Indirect Cost/ Expenses

We already got Gross Profit in the question = 5,00,000/-

SO,  Total of Indirect Income =  50,000/-

Total of Indirect Expenses/cost =  92,500 + 25,000 + 50,000

                                                          = 1,67,500/-

N.P. = 5,00,000 + 50,000 – 1,67,500

N.P. = 3,82,500/-

Example 3 : – 

Gross Profit of the year is Rs. 2,00,000, Further Mr Z paid a salary to his employees 80,000/-, Freight on Sales of goods Rs. 5,000, Depreciation of all assets Rs 20,000, Interest on loan Rs 10,000 and Taxes Rs 15,000. In addition to that, he has received the Rent from the Tenant for the let-out building Rs. 25,000. Mr  Now calculates the N.P. (EAIT) earned by Mr Z.

Solution: –

N.P = Gross Profit + Indirect Income – Indirect Cost/ Expenses

We already got Gross Profit in the question = 2,00,000/-

SO,  Total of Indirect Income =  25,000/-

Total of Indirect Expenses/cost =  80,000 + 5,000 + 20,000 + 10,000 + 15,000

                                                          = 1,30,000/-

N.P. = 2,00,000 + 25,000 – 1,30,000

N.P. = 95,000/-

Check out the Difference between Gross and Net Profit.

Difference between Gross profit and Net Profit

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What is Gross profit – Explanation with Examples

What-is-Gross-Profit

Gross Profit (G.P.) is that part of the revenue which is left after deducting all direct cost/expenses from the Net Sale. All direct cost/ expense means Cost of Goods Sold (COGS). COGS include all the cost incurred on the production of the product in the manufacturing unit or in the trading unit cost of requisition of the product.

The Formula of Gross Profit : –

“Gross Profit = Net Sales – Cost of Goods Sold” 

  • Net Sales = Total Sales – Sales Return
  • COGS =  Opening Stock + Net Purchase + Direct Expense – Closing Stock.
    • Net Purchase = Total Purchase – Purchase Return

Example No. 1 : – 

Mr X purchase goods worth 100,000 and spent 1,000 on freight and transportation, 500 on octroi. He sold these goods to Mr Y for 120,000. Calculate the Gross Profit earned by Mr X.

Solution: –

First, calculate Cost of Goods Sold: –

COGS =  Opening Stock + Net Purchase + Direct Expenses – Closing Stock

 0 + 100000+1000+500-0

COGS = 101500/-

G.P. = Net Sale – COGS
           120000-101500
G.P. = 18,500/-

Example No. 2 : – 

As on 01/04/2019 A&b Co. ltd. have a stock of goods worth Rs. 75,000. The purchase goods worth 4,50,000 during the year and spent 10,000 on Carriage, 2,500 on loading. They sold goods for worth Rs. 5,35,000 during the year and after that at the end of the year Rs 65,000 stock of goods left. Calculate the Gross Profit earned by Mr X.

Solution: –

First, calculate Cost of Goods Sold: –

COGS =  Opening Stock + Net Purchase + Direct Expenses – Closing Stock

 75000 + 450000 + 10000 + 2500 – 65000

COGS = 4,72,500/-

G.P          = Net Sale – COGS
                    535000 – 472500
G.P.         = 62,500/-

Example No. 3 : – 

As on 01/04/2019 A&b Co. ltd. have a stock of goods worth Rs. 35,000. The purchase goods worth Rs 1,50,000 and purchase return Rs 15,000 during the year and spent 2,000 on Carriage, 400 on loading. They sold goods for worth Rs. 2,35,000 and sale return Rs. 25,000 during the year and after that at the end of the year Rs 12,400 stock of goods left. Calculate the Gross Profit earned by Mr X.

Solution: –

First, calculate Cost of Goods Sold: –

COGS =  Opening Stock + Net Purchase + Direct Expenses – Closing Stock

 35000 + (150000 – 25000) + 2000 + 400 – 12400

COGS = 1,50,000/-

G.P          = Net Sale – COGS
                    (235000- 25000) – 150000
G.P.         = 60,000/-

Check out the difference between Gross and Net Profit.

Difference between Gross profit and Net Profit

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What are Incomes – its types and examples

What-are-incomes

Incomes mean the amount earned by the business from the business operation and other activities. Income is also known as Revenue. In other words, The amount earned from Sale of goods and services and other non-operation works. These incomes are routine incomes and will have to receive throughout the year.

The types of Incomes :

The Incomes also can be divided into two types. These are explained as under:

  1. Direct Income 
  2. Indirect Income

1. Direct Income:-

The incomes which are earned from the business operational activities are known as Direct Income. In other words, income earned from the sale of that goods and services in which business is dealing. 

Why this income is separated in a different group?

Because with the help of these we can calculate the Gross profit of the business in a particular financial year.

These incomes are differed as per the model of business. We are further classified them into two major subcategories explained as follows: –

  1. Physical Product Business model
  2. Services Business Model

Examples: –

  1. Physical Product Business model:
    1. For the Computer Parts Manufacture, the income earned from the sale of computer parts will be Direct Income of their business.
    2. For the Car Manufacture Company, the income earned from the sale of cars and sale of spare parts will be Direct Income of their business.
    3. For the Books Trader, The income earned from the sale of books will be Direct Income of their business.
  2. Services Business Model:
    1. For the Tuition Center, The income earned from the fee charged to the students will be Direct Income of their business.
    2. For the Doctor, The income earned from the fee charged to the patient will be Direct Income of his business.

2. Indirect Expenses: 

The incomes which are earned from the non-operational activities of the business are known as Indirect Income. In other words, income earned from the sale of scrap or profit earned from the sale of any assets.

These Incomes are separated to calculate the Net profit of the business in a particular financial year.

Examples: –

  1. Profit on Sale of Assets 
  2. Commission Charged on other business to do their work
  3. Discount Received at the time of making payment to vendors
  4. Sale of Scrap

Differences between the Direct and Indirect Expense:

Direct and Indirect Expenses: Differences

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What are Expenses – its types and examples

What-are-Expenses

Expenses mean the amount spent by the business for running the business operation. The expenses are also known as Revenue Expenditure. In other words, The amount spends on running the process of production and purchase of goods. These expenses are routine expenses and will have to pay again and again

In short, we will drive the benefit from these expenditures in the current year only.

The types of Expense:

The Expenses can be divided into two types. These are explained as under:

  1. Direct Expense
  2. Indirect Expense

1. Direct Expense:-

The expenses which are related to the production process or purchase of goods are called direct expenses. In other words, all expenses which have a direct relation with the process of production of goods and purchase of goods.

Why this expense is separated in a different group?

Because with the help of these we can calculate the Gross profit of the business in a particular financial year.

These expenses are differed as per the model of business. We are further classified them into two major subcategories explained as follows: –

  1. For the Manufacturing Business model
  2. For the Trading Business Model

Examples: –

  1. In Manufacturing Concern:
    1. Purchase of Raw Material
    2. The wages paid to the factory worker
    3. Factory Staff salary
    4. Factory Lighting and Heating
    5. Freight or carriage inwards
    6. Octroi on the Purchase of Raw Material
    7. Factory rent
    8. Factory utilities
    9. Factory building insurance
    10. Depreciation on Plant and Machine
    11. Equipment setup costs
    12. Equipment Repair and maintenance
    13. Factory supplies
    14. Factory small tools and die charged to expense
    15. Import Duty
    16. Custom Duty
    17. Dock Charges
    18. Fuel, Gas and Water
    19. Royalty
    20. Packaging Material or charges
    21. Commission on Purchase
  2. In trading Concern
    1. Purchase of Goods
    2. Freight or carriage inwards
    3. Octroi on the Purchase of goods
    4. Unloading of goods
    5. Import Duty
    6. Custom Duty
    7. Dock Charges
    8. Packaging Material or charges
    9. Commission on Purchase

2. Indirect Expense: 

The expenses which are not related to the production process or purchase of goods are called indirect expense. In other words, all expenses other than the direct expense is known as indirect expense. These expenses are separated to calculate the Net profit of the business in a particular financial year.

Examples: –

  1. Salary of the office employees
  2. Electricity Bill
  3. Rent
  4. Taxes
  5. Freight or carriage outwards
  6. Travelling Expense
  7. Printing and Stationery
  8. Postage and Telegram
  9. Commission paid on Sales
  10. Publicity and Expense
  11. Accounting and Auditing Fee
  12. Legal fee
  13. Office Expense
  14. Repair and maintenance
  15. Staff Welfare
  16. Group Insurance of employee
  17. Depreciation
  18. Bad debts
  19. Office building insurance
  20. Mobile and Telephone Expense
  21. Interest
  22. Miscellaneous Expense

Differences between the Direct and Indirect Expense:

Direct and Indirect Expenses: Differences

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What is Sale? – Explanation with Examples

What-is-sale

The sale means giving the ownership of any goods or assets, by receiving/will be received the predetermined price of them. It may be in cash or credit. In credit means, when business sold goods or assets without receiving the predetermined price of them, This due amount will be received in the future.

In accounting, the sale Ledger account is maintained only for goods. When the asset is purchased then it will be debited to the assets account. 

Examples of Transactions of Sale: –

  1. Sold goods to M/s A&B Ltd. worth Rs 10,000.
  2. Sell goods worth Rs 50,000 to Deepak Pvt. ltd for cash.
  3. Sale of goods for Rs 10,000.
  4. Sold Plant worth Rs 15,000. 
  5. Old newspaper worth Rs 1,500, Sold to Shyam & sons. 

Explanation of Examples: –

The first three numbers of examples are is treated as a sale in the accounting and it will be entered in the Sale account. 

But the Fourth number of example is related to the sale of the asset. So, this will not be entered into the sale account. It will be credited to the asset account i.e. Plant and Machine a/c. 

and in last, The fifth transaction is related to the other income. So, it will also not be entered in the sales account. It will be credited to the income account i.e. Scrap a/c.

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What is Purchase? – Explanation with Examples

What-is-Purchase

Purchase means getting the ownership of any goods or assets, by paying the predetermined price of them. It may be in cash or credit. In credit means, when business buys goods or assets without paying the predetermined price of them, This due amount will be paid in future.

In accounting, Purchase Ledger account is maintained only for goods. When the asset is purchased then it will be debited to the assets account. 

Examples of Transactions of Purchases: –

  1. Buy goods from M/s ABC Ltd. worth Rs 10,000.
  2. Buy goods worth Rs 50,000 from CD Pvt. ltd for cash.
  3. Bought goods for Rs 10,000.
  4. Bought Plant worth Rs 15,000.
  5. Stationery worth Rs 1,500, Bought from Ram & sons. 

Explanation of Examples: –

In the first three numbers of examples are is treated as purchase in the accounting and it will be entered in the purchase account. 

But the Fourth number of example is related to the purchase of the asset. So, this will not be entered in the purchase account. It will be debited to the asset account i.e. Plant and Machine a/c. 

and in last, The fifth transaction is related to the expense account. So, it will also not be entered into the purchase account. It will be debited to the Expense account i.e. Stationery a/c.

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What is Expenditure – its types and examples

What-is-Expenditure

Expenditure means that amount which has spend or will be spent by business on the purchase of goods and to avail the services. These can be in cash or on credit or in the fund. Examples of expenditure for business are shown as following: 

  • Purchase of
    • Raw Material/Stock
    • Stationary
    • consumable items 
    • Assets 
  • Bill of Electricity
  • Wages and Salaries
  • Rent for building 
  • Taxes and duties
  • Postage and Telegram
  • Mobile and Telephone
  • Depreciation

Types of Expenditures: 

The expenditure is of two types. These are shown below:-

  1. Capital Expenditures
  2. Revenue Expenditures

1. Capital Expenditure: –

Capital expenditure is that amount spend on the more valuable goods or services which is used for a long duration i.e. more than one year. In other words, the amount spent on the creation of capital asset or to increase the working capacity of the existing asset is known as capital expenditure. Because of the huge amount invested in this process so we have to capitalize this amount.

In short, we will drive the benefit from these expenditures in the current year as well as in the future year also.

Example: – 

Purchase of new Plant and Machine, the creation of a new building or expansion of an old building, purchase of a new car, furniture, computer etc.

2. Revenue Expenditure: –

Revenue expenditure is that amount spend on the more goods or services which is used/consumed in a short duration i.e. within the one year. In other words, The amount spends on running the process of production and sale of goods. These expenses are routine expenses and will have to pay again and again

In short, we will drive the benefit from these expenditures in the current year only.

Example: – 

Salary & wages, Rent, Office & factory Electricity, Freight Inward & outwards, Travelling Expenses, Marketing Cost, Publicity and Advertisement, Postage and Telegram, Printing and Stationery, Mobile and Telephone, Staff welfare, Repair and maintenance, insurance, etc.

Check out the difference between capital and revenue expenditures click on the below link:-

Capital and Revenue expenditures: Meaning and Differences

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Cost of Goods Sold (COGS) – its Formula and example

What-is-Cost-of-Goods-Sold-COGS

Cost of Goods Sold (COGS) is the amount of expenses that are directly related to the process of the manufacturing of the final product or cost of goods purchases and direct expenses incurred on it but indirect expenses are not included in it. 

In all direct cost of the product in known as Cost of Goods Sold (COGS) 

To understand the meaning of Cost of Goods Sold (COGS) more simply, first we have to divide the business into two types. These are shown below:

Types of Business: 

  1. Production Business 
  2. Trading Business. 

1. Production Business: –

In the Production Business, the amount which has spent by the business to produce finished products is known as the cost of goods sold (COGS). Examples are shown below: –

2. Trading Business: – 

The amount of expenses which has been spent by the business on the purchase of goods and bring these goods in-store is known as the cost of goods sold(COGS). It includes the purchase price of goods and all expenses incurred on the process of Purchase. 

The formula of Cost of Goods Sold

COGS = Opening Inventory + Net Purchase + Direct Expenses – Closing Inventory

  • Opening Inventory means the value of inventory which is available at the start of the financial year or the period for which we want to calculate the COGS. In financial year start from 01-April and ends on 31-march.
  •  Net Purchase means total purchase less purchase return within the current financial year or the period for which we want to calculate the COGS.
  • Direct Expenses means that amount which the business spent on purchases of the material within the Financial year or the period for which we want to calculate the COGS.
  • Closing Inventory means the value of inventory which is left at the end of the financial year or the period for which we want to calculate the COGS. In financial year start from 01-April and ends on 31-march.

Example for Cost of Goods Sold:

Example 1 for Production Business:

  • Opening Inventory
    • Raw Materials Rs. 50,000
    • Work in progress Rs. 35,000
    • Finished Stock Rs. 85,000
  • Total Purchase Rs. 9,00,000
  • Purchase Return Rs. 27,000
  • Direct Expenses
    • Carriage Paid Rs. 17,000
    • Wages Rs. 1,80,000
    • Factory Power Rs. 50,000
  • Closing Inventory
    • Raw Materials Rs. 70,000
    • Work in progress Rs. 13,000
    • Finished Stock Rs. 97,000

Solution: –

COGS= Opening Inventory + Net Purchase + Direct Expenses – Closing Inventory 

= (50,000 +  35,000 + 85,000) + (9,00,000 – 27,000) + (17,000 + 1,80,000 + 50,000) – (79,000 + 13,000 + 97,000)

COGS = Rs. 11,10,000/-

Example 2 for Production Business:

  • Opening Inventory Rs. 67,000
  • Total Purchase Rs. 4,37,000
  • Purchase Return Rs. 37,000
  • Direct Expenses
    • Carriage Paid Rs. 17,000
    • Octroi Rs. 3,000
  • Closing Inventory Rs. 88,000

Solution:-

COGS= Opening Inventory + Net Purchase + Direct Expenses – Closing Inventory 

= 67,000 + (4,37,000 – 37,000) + (17,000 + 3,000) – 88,000

COGS=3,99,000/- 

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What is Inventory – Types of Inventories – Example

What-is-Inventory

Inventory meaning that Material or Items which are owned by the business for further production of goods and for sale. To understand the meaning of Inventory more simply, first we have to divide the business into two types. These are shown below: 

Types of Business: 

  1. Production Business 
  2. Trading Business. 

1. Production Business: –

In this type of business, The business brought goods to produce further goods.An example is shown below.

  • Carpenter bought wood to make furniture.
  • Tata Motor bought iron or steel to produce Cars.
  • Building Bought Bricks and Cement to build a Building. 
  • Sultan Cand Publisher used paper to print a book. 

The inventory can be divided into three types. These are shown below: 

  1. Raw Material 
  2. Work In Progress 
  3. Finished Goods/Products
1. Raw Material 

The products that are used by business to make final products are known as raw material for business. Examples are shown below: 

  • For carpenter Woods are Raw Material.
  • For Tractor company, Iron is Raw Material.
  • For Sultan Cand Publisher papers are Raw Material.
2. Work In Progress:

Work In Progress means that product on which some part of the work is pending at the end of the Financial year or the day when we are calculating the value of Inventory. This will not be treated as Raw Material or not a Finished Product because neither it can be used to make another product nor It is not ready to Sell. Examples are shown below: 

  • A carpenter making a table but at the end of the day, or last day of the financial year the polishing work on it is pending.
3. Finished Goods/Products

The Products which are ready to sell are known as Finished Goods/Products. Examples are shown below: 

  • Wood Tables made by the carpenter. 
  • Book printed by Sultan Cand Publisher
  • The car produced by Tata Motors.

2. Trading Business 

In this type of business, The business brought goods to sell them to the end-user or consumer. In short, Trading Business means sale and purchase of goods. An example is shown below.

  • Furniture store-bought Table from Carpenter to sell it to end-user or consumer.
  • Books Seller bought Books from Sultan Cand Publisher to sell it to end-user or consumer.

Placement of an inventory in the balance sheet: –

The placement of an inventory in the balance sheet should be shown under the group Current Assets. This is shown in the following format of the balance sheet and highlighted with orange colour: –

Name of the Entity
Balance Sheet as on 31st March, _______
Liabilities  Amount Assets  Amount 
Current Liabilities    Current Assets   
Trade Creditors    Cash in hand   
Bills Payable    Cash at Bank  
Outstanding Expenses    Inventories   
Advance/Unearned Incomes   Bills payable   
Short term loans    Sundry Debtors   
Non-Current Liabilities    Prepaid Expenses   
long terms loans   Accrued Incomes   
Debentures    Fixed/Non-Current Assets  
Capital   Building   
Add:  Net profit    Land   
   interest on Capital
  Plant & machine   
Less:  Drawings    Furniture & fixture   
   Net Loss    Goodwill   
       
       

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