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Entrepreneurs and Profits, Calculating Profits

telecommunications giant, efficiency expert, largest corporations, average worker, small firm

The dollar value of profits earned by U.S. businesses—about $700 billion a year in the late 1990s—is a great deal of money. However, it is important to see how profits compare with the money that business owners have risked in the business. Profits are also often compared to the level of sales for individual firms, or for all firms in the U.S. economy.

Accountants calculate profits by starting with the revenue a firm received from selling goods or services. The accountants then subtract the firm’s expenses for all of the material, labor, and other inputs used to produce the product. The resulting number is the dollar level of profits. To evaluate whether that figure is high or low, it must be compared to some measure of the size of the firm. Obviously, $1 million would be an incredibly large amount of profits for a very small firm, and not much profit at all for one of the largest corporations in the country, such as telecommunications giant AT&T Corp. or automobile manufacturer General Motors (GM).

To take into consideration the size of the firm, profits are calculated as a percentage of several different aspects of the business, including the firm’s level of sales, employment, and stockholders’ equity. Various individuals will use one of these different methods to evaluate a company’s performance, depending on what they want to know about how the firm operates. For example, an efficiency expert might examine the firm’s profits as a percentage of employment to determine how much profit is generated by the average worker in that firm. On the other hand, potential investors and a company’s chief executive would be more interested in profit as a percentage of stockholder equity, which allows them to gauge what kind of return to expect on their investments. A sales executive in the same firm might be more interested in learning about the company’s profit as a percentage of sales in order to compare its performance to the performances of competing firms in the same industry.

Using these different accounting methods often results in different profit percent figures for the same company. For example, suppose a firm earned a yearly profit of $1 million, with sales of $20 million. That represents a 5-percent rate of profit as a return on sales. But if stockholders’ equity in the corporation is $10 million, profits as a percent of stockholders’ equity will be 10 percent.



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