I find, no matter what a client's business, I am frequently asked the same questions. So I am going to tackle some of them here, starting with "What is the difference between Gross Profit, Net Profit and Taxable Profit?"
Answer:
No matter what industry you operate in all businesses have some things in common and finance is one.
Your business will create sales which make up your turnover.
Your business will incur costs related to these sales, these are known as direct costs and are things like materials (for companies supplying goods) and labour (for companies supplying goods and/or services).
So the first profit to look at is Gross. This is made up of
Turnover less direct costs = Gross Profit.
What constitutes a good gross profit depends on your industry. For example, an engineering company will be looking to make a gross profit of between 40-50% whereas a web designer will be looking to make a gross profit of around 75-80% as they will have significantly less direct costs.
There are then costs that the business incurs regardless of whether anything is sold, these costs are overheads and are things like insurance, rent, electric.
So the second profit is Net. This is made up of
Gross Profit less overheads = Net Profit
As with gross profit, the amount of net profit varies per industry
Finally is the Taxable Profit. You would think your net profit is the taxable profit but this is not necessarily the case. There are some costs the business has to show in the accounts to ensure they give a fair reflection of the value of the business, for example depreciation, that is not a recognised cost for tax. The main reason, using depreciation as the example, can be subjective and each business chooses how much depreciation is to be counted as a cost. This figure affects the net profit and therefore the tax paid. There are other costs that are not recognised for tax too, a common one being ‘entertainment’. Again it is a business decision how much to spend on business entertainment and this could be used to reduce the amount of tax paid. Would you rather pay for your client to go away for the weekend (and likely get more business from them) or pay the tax man!
So Taxable Profit is made up of
Net Profit plus non-taxable expenses = Taxable Profit
Let us see an example:
JD is a retail company, selling goods online made in their workshop. JD sells their product at £50 each and has total sales for the year of £100,000.
JD buys their supplies to make the goods from KF at a cost of £15 each. They pay themselves £10 per product to make the finished item. JD has direct costs of £30,000 for supplies and £20,000 for labour, £50,000 in total.
JD’s Gross Profit is;
£100,000 - £50,000 = £50,000.
JD also has the following overheads (per year):
Premises to pay for at £10,000,
Rates £2,000,
Electric, water and gas at £4,500,
Advertising at £1,500,
Depreciation of their machinery of £3,500,
Entertainment of £500
Professional fees of £1,000
Total overhead spend is £23,000
JD’s Net Profit is;
£50,000 - £23,000 = £27,000
JD’s Taxable Profit is;
£27,000 + £3,500 (depreciation) + £500 (entertainment) = £31,000.