How to Calculate Profits From the Balance Sheet

The greater your small-business profit, the greater are the assets that show up on the balance sheet at the end of the day. However, the relationship between earnings, or profit, and balance sheet assets isn't entirely straightforward. You can spend or invest income in any number of ways, and accounting conventions such as depreciation make the equation even more complicated.

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You can't directly calculate profits from a balance sheet, although you can see a general trajectory of saving and investing from profitable years or of borrowing and depleting assets during years when you incur losses.

A profit and loss statement, also known as an income statement or P&L, summarizes everything your business earned and spent during a specific period. It divides income into categories, such as wholesale and retail sales. It categorizes expenditures, splitting them into cost of goods sold, or expenses directly associated with producing your offerings, and other fixed costs, such as rent and advertising. The bottom line of the profit and loss statement reflects net income, or the amount left after subtracting total expenses from total revenue.

A balance sheet reflects your company's overall financial situation at a particular moment in time. It lists assets, or everything the company owns, and liabilities, or everything it owes. It calculates owner's equity by subtracting total assets from total liabilities. The purpose of a balance sheet isn't specifically to show or calculate profits or earnings, but rather to show how the profit or loss the business earned has played out through the decisions you made about how to invest and finance your operations.

For example, if you run a sole proprietorship business, you have the option of leaving the profits in your business as working capital or withdrawing them to cover personal expenses. If your business retains these earnings, the balance sheet shows that you have this cash on hand. If you withdraw the money, it doesn't show up on your balance sheet because your business no longer holds it. Either way, your profit and loss statement shows the same amount of earnings.

P&L and balance sheet formats follow basic conventions that present your financial information clearly and communicate legitimacy to lenders and potential investors. The balance sheet format lists assets on the left or at the top of the page, and liabilities on the right or at the bottom portion of the page. The income statement format lists incoming revenue at the top of the page and outgoing expenditures at the bottom.

An accounting program such as QuickBooks takes the information you input over time and seamlessly imports it into financial statements that lay out your information clearly and accurately, as long as you enter data that is thoroughly and sensibly organized. Alternately, you can create a net profit formula in Excel by setting up a spreadsheet that subtracts total expenses from total revenue.

The business model is a fundamental factor behind both the bottom line reflected in a profit and loss statement and the assets and liabilities reflected on a balance sheet. The gross profit margin shows the income percentage after subtracting variable costs, such as manufacturing materials and production labor. The net profit margin further subtracts fixed costs, such as rent, payroll, management salaries, and permits and licenses.

Net profit margin analysis is a deep dive into your company's spendings and earnings. It shows the strengths and weaknesses of your business model and provides insights into how these spendings and earnings show up on your balance sheet. For example, if your business is profitable and you invest a sizable portion of this income in equipment and infrastructure, a net profit margin analysis may show you are short of cash because you purchased assets that are being depreciated over time and not because your operations are losing money.