Use the business’s most recent income statement to quickly identify the total profit and cost amounts. Configure the profit and cost totals manually if an income statement is not available and to check the accuracy of the statement’s information.
Step 2
Identify the business’s costs. Add all the expenses incurred as a result of doing business, including development and liability expenses, payroll and administrative expenses, labor costs, loans and selling expenses.
Step 3
Calculate the business’s net profit by first identifying the business’s gross profit. Configure the cost of goods sold by adding the total amount of beginning inventory to the costs of purchases and labor, and then subtract that total from the value of the ending inventory. Calculate the gross profit by subtracting the business’s net sales from its cost of goods sold.
Step 4
Determine the business’s net profit by subtracting the business’s gross profit amount from its total expenses. Subtract the business’s income tax amounts from the net profit to identify the total net profit after taxes.
Step 5
Use the profit and cost information to determine if the business is operating efficiently and earning all of its potential income. Use the business’s profit margin ratio to help identify its efficiency. Calculate the profit margin by dividing the business’s net profit by its net sales, which compares the business’s earnings after expenses against its total sales amounts. Examine the business’s expenses, costs and prices carefully if the profit margin results in a low percentage rate, such as below 15 percent, as this means that the business earns very little income with each product sale.
Step 1
Record the value of your inventory at the start of the year. Inventory is simply the value of the goods your business has available for sale. Typically, this figure is the same as the closing value of your inventory for the prior year.
Step 2
Add the amount of money you spent on acquiring new merchandise. For example, if you run a clothing business and buy 50 new dresses that you intend to sell, the cost of those dresses will be included in your cost of sales. If you operate a production business, you can also include the amount you spend on any raw materials necessary for making your product. For example, if you manufacture steel screws, the raw steel you purchase to make those screws is included in your new merchandise expense. This figure should not include items purchased for personal use, or money spent on inventory or product that is not available for sale.
Step 3
Calculate your total overhead. Different IRS rules may apply for this step depending on the nature of your business. For construction and manufacturing or mining businesses, you can add in the value of wages paid to workers, supplies purchased for the business and other overhead costs, such as office and utilities expenses. For more traditional wholesale or retail operations, you must report these overhead costs as business expenses and not add them to the cost of sales. The defining line for the IRS is whether your workers are "production workers," meaning they actually construct or manufacture your product for you. For most small businesses, workers are not production workers.
Step 4
Add your new purchases and allowable overhead expenses to your initial inventory value.
Step 5
Subtract the value of your inventory at year-end. This will provide you with your cost of sales. Expressed as a formula: beginning inventory + inventory purchases and expenses - ending inventory = cost of sales, also known as cost of goods sold.
