What is the difference between gross profit and net profit?
Gross profit is what you make on the goods themselves: sales minus what those goods cost you. Net profit is what is left after you also pay the costs of running the shop. Gross profit tells you whether your prices are right; net profit tells you whether the business is making money.
The terms you need:
- Sales (revenue): what customers paid, after returns and discounts. If your shop is registered for VAT, use sales without VAT, because the VAT belongs to KRA, not to you.
- Cost of goods sold: what you paid for the goods you sold in the period.
- Gross profit = sales − cost of goods sold
- Gross margin = gross profit ÷ sales × 100
- Expenses: rent, wages, electricity, water, transport, licences, M-Pesa and bank charges, and every other cost of running the shop.
- Net profit = gross profit − expenses
What is the difference between markup and margin?
Markup is profit as a percentage of the cost; margin is profit as a percentage of the selling price. The same item always has a higher markup than margin, which is why mixing them up leads to prices that earn less than you planned.
- Markup = (selling price − cost) ÷ cost × 100
- Margin = (selling price − cost) ÷ selling price × 100
Take a 2 kg packet of sugar bought at KSh 250 and sold at KSh 290. The profit is KSh 40. The markup is 40 ÷ 250 = 16%. The margin is 40 ÷ 290 = 13.8%.
| Markup on cost | Margin on selling price | An item costing KSh 100 sells at |
|---|---|---|
| 10% | 9.1% | KSh 110 |
| 20% | 16.7% | KSh 120 |
| 25% | 20% | KSh 125 |
| 33.3% | 25% | KSh 133 |
| 50% | 33.3% | KSh 150 |
| 100% | 50% | KSh 200 |
To set a price for a target margin, divide the cost by one minus the margin. For a 20% margin on an item that costs KSh 400, the price is 400 ÷ 0.80 = KSh 500. Adding 20% to the cost gives KSh 480, which is only a 16.7% margin.
How do you work out the cost of goods sold?
Cost of goods sold is the cost of the stock that left the shop through sales, not the amount you spent on stock in the month. If you keep a stock book, work it out from your stock counts, all valued at cost:
Cost of goods sold = opening stock + purchases − closing stock
A minimart starts the month with KSh 820,000 of stock at cost, buys KSh 1,030,000 during the month, and counts KSh 850,000 at the end. Its cost of goods sold is 820,000 + 1,030,000 − 850,000 = KSh 1,000,000.
This method has one weakness: anything stolen, damaged or expired is counted as sold and hides inside the cost of goods sold. A system that records the cost of each item as it is sold separates the two, so stock loss shows up on its own when you do a stock take.
Why use average cost?
Buying prices change from one delivery to the next, so you need a fair cost for each item you sell. Average cost takes the weighted average of what you paid for the stock you hold.
If you bought 10 cartons of cooking oil at KSh 1,200 and then 20 more at KSh 1,260, the average cost is (10 × 1,200 + 20 × 1,260) ÷ 30 = KSh 1,240 a carton. Every carton you sell costs KSh 1,240 until the next delivery changes the average. It avoids guessing which delivery a carton came from, and it keeps profit steady when prices move.
How do returns and discounts affect profit?
Both reduce sales, and discounts come straight out of your profit. An item that costs KSh 400 and sells at KSh 500 earns KSh 100. Give a KSh 50 discount and it earns KSh 50: the price fell by 10%, but the profit halved.
A return reverses the sale. If the item goes back on the shelf, its cost goes back into stock too and the profit on that sale disappears. If it is damaged and cannot be sold again, the shop also loses the cost of the item.
A worked monthly example for a minimart
Here is one month for a minimart in Thika, with every figure at cost or without VAT.
| KSh | |
|---|---|
| Sales before returns | 1,262,000 |
| Returns | −12,000 |
| Net sales | 1,250,000 |
| Cost of goods sold | −1,000,000 |
| Gross profit (20% margin) | 250,000 |
| Rent | −45,000 |
| Wages (three staff) | −66,000 |
| Electricity | −9,000 |
| Water and rubbish collection | −2,000 |
| Internet and airtime | −3,000 |
| Business permit (yearly fee ÷ 12) | −2,500 |
| Transport and deliveries | −6,000 |
| Packaging | −4,500 |
| Petty cash (cleaning, tea, small repairs) | −3,500 |
| M-Pesa and bank charges | −2,500 |
| Total expenses | −144,000 |
| Stock loss found at stock takes (at cost) | −8,000 |
| Net profit | 98,000 |
The minimart sold KSh 1.25 million of goods and made a net profit of KSh 98,000, a net margin of 7.8%. That is the figure that pays the owner and grows the business.
In the same month, the owner took KSh 50,000 for school fees and repaid KSh 30,000 of a bank loan. Neither is an expense, so neither belongs in the profit figure, but both take cash out of the business. Only the interest on a loan is an expense. After both payments, KSh 18,000 of the month’s profit is left in the business.
What are the most common mistakes when calculating shop profit?
Treating takings as profit, forgetting stock loss and mixing personal spending with the shop’s money are the mistakes to watch for first. The others are less obvious but just as costly.
- Counting cash as profit. The cash in the drawer and the bank includes money you owe suppliers, VAT you collected, and money for the next delivery. A good week of takings is not a good week of profit.
- Forgetting stock loss. Expired, damaged and stolen goods are a real cost. If you never count your stock, your profit is higher on paper than in reality.
- Mixing personal and business spending. Taking stock home or paying household bills from the till without recording it makes your figures meaningless. Record what you take as drawings.
- Using purchases instead of cost of goods sold. A month when you stocked up looks like a loss, and the next month looks like a windfall.
- Leaving out yearly costs. Licences, insurance and repairs should be spread over the months they cover.
- Confusing markup and margin. Adding 25% to cost when you wanted a 25% margin leaves you with 20%.
- Ignoring credit sales. Sales on account count when they are made, but the cash comes later. A shop can be profitable and still run out of cash if customer credit keeps growing.
How often should you work out your profit?
Work out net profit every month, for the same calendar dates each time, so that one month can be compared with the next. Check gross margin more often, even weekly, because a supplier price rise you have not passed on shows up there first.
Compare each month with the same month last year as well as with the month before. School fees, holidays and harvests change what Kenyan customers spend, so January and December rarely look alike. If net profit falls while sales rise, look at three things in order: gross margin (prices and costs), stock loss, and expenses that have crept up. Our guide on balancing the cash drawer helps keep petty cash, one of the easiest expenses to lose track of, under control.
How Wave POS works out your profit
Wave POS measures profit at the cost of each sale, so you do not have to work out cost of goods sold from stock counts.
- Cost at the time of sale. Stock is valued at average cost, and every purchase you receive updates that average. Profit uses each item’s cost at the moment it was sold, so a later price rise does not change last month’s profit.
- Sales net of returns. Sales figures already take returns off.
- Expenses with categories. Enter rent, wages and bills in the back office, or record petty cash at the till when cash leaves the drawer. Both appear in your expenses, by category.
- Profit and loss report. Sales, cost of goods sold, gross profit, expenses and net profit for the period you choose. The expenses report shows where the money went by category.
- Stock loss in view. Stock take differences and approved adjustments are recorded as stock movements, so you can see what was lost alongside your profit.
- Exports. Every report exports to Excel, CSV or PDF for your accountant.
Read more about expenses and profit and the other sales reports.