What are the real profits of a business?

You are a business owner. Where do you spend most of your time and energy? On the short and medium term performance of your business? On the results at the end of your fiscal year? Ultimately, are you able to determine the real profits of your business?

Many business owners don’t know the answer to this question.

Calculating and determining the real profits of your business is important. If you want to appraise your business or increase its profitability, it is a good place to start.
How to calculate a business’ profits? Quick method

To help you understand this exercise, let’s use an example.  We will presume that Company A and Company B work in the same field.
This table shows a profit analysis of both companies. It includes the expenses that are usually considered and reported for tax purposes. The table allows us to quickly and easily see where the company stands.

At first glance, Company A is more profitable than Company B. But is this really the case?

How to determine the real profit of a business?

This first table provides a summary calculation. Actually, the calculation needs to go deeper to get a more accurate picture of the company.

First, it is essential to adjust, at fair market value, the salary paid to the shareholder and related parties (spouse/children). We must replace their salary by the one they would have paid to a third party to do the same job.
Then we need to add discretionary expenses. These are expenses that are not related to the company’s operations. For example, it includes donations to charities and other expenses that may be taken out without affecting the company’s operations.  In some cases, rent paid to a related party must be adjusted.  If the business owner is also the building owner where his company is based and is leasing the building to the company, the rent amount may not reflect the amount that would have been asked to a third party for the same premises. It must be adjusted according to the rent which would have been paid, if applicable.

After making various adjustments, you will be able to see that both companies actually make the same level of profits even if Company A seemed more profitable than Company B initially.

What should we remember when it comes to calculating a company’s real profits?

You must remember that every business is unique, the situation described above is not applicable to all companies.  Each company has its own income and expenses. When it is time to calculate the real profits of your business, it is important to take the most elements into consideration.
Ask yourself; is there anything that could have been paid or charged differently if you had dealt with a third party?  If the answer to this question is yes, for rent, a salary, etc., you need to make an adjustment.

This calculation is very important to get the reak profitability of the company and to determine whether actions should be taken to increase its profitability.  On many occasions, I was able to note that this analysis provides a better picture of the situation of the company and allows the business owner to make the appropriate decisions.