Book Profit Meaning

We can define Book profit as the leftover money after the entity pays off all its expenses, as shown in the profit and loss statement. In other words, it refers to money earned by an entity during a financial year by selling products and services deducted from all the expenses incurred during the same financial year.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Book Profit (wallstreetmojo.com)

How to Calculate Book Profit from Cash Profit?

As we have discussed, book profit is the profit as shown in the profit and loss account of the entity and is considered to be the actual profits because it is considered all cash and non-cash transactionsNon-cash TransactionsNon-cash expenses are those expenses recorded in the firm’s income statement for the period under consideration; such costs are not paid or dealt with in cash by the firm. It involves expenses such as depreciation.read more. Like revenue generated through sales made on credit and charging annual depreciation, no actual cash transaction is just book entries.

Cash profit is the surplus generated through actual cash flows within an entity. It is calculated by subtracting all the cash outflows (including all paid expenses like salary, rent, bills, etc.) from the cash inflows (including cash sales). Cash profit can also be calculated using book profits by adding back all the non-cash expenses (like depreciation debited in Profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization’s revenue and costs incurred during the financial period and is indicative of the company’s financial performance by showing whether the company made a profit or incurred losses during that period.read more and subtracting the non-cash revenues (like credit sales).

Book Profit calculation Example

As calculated by Mr. Solo, the owner of a sole proprietorship firm, the Cash Profit amounted to $10,000 in the previous year based on actual recipes and payments. Mr. Solo charges an annual depreciation of $800 on its assets. The credit sales (not included in cash profit) made amounted to $2300. Mr. Solo wants to find Book Profits.

Solution:

= $ (10000 – 800 + 2300) = $11500

Book Profit: Financial Instruments or Investment Tools

The profits made on investments that have not been realized yet are called book profits. That means when, for example, the current value of securities becomes higher than the actual cost paid, and the securities are yet not sold but still owned by the holder, then such profits are termed as book profits.

Example:

Mr. John bought 100 shares of ABC Ltd at $90 per share a year ago in January 2018. The stock during January 2019 is trading for $95. John, a long-term investor, is expecting the stock prices to rise further in the future and, hence, decided to remain invested.

Hence John did not sell the stocks and calculate the profits earned during the one-year interval as follows:-

Cost Paid = 100 shares * $90 per share = $9000

Current Value = 100 shares * $95 per share = $9500

Book Profit (B – A) = $(9500 – 9000) = $500

There is a possibility that this profit might erase if the prices go down. E.g., during 2019, due to poor economic growth and high market volatility, the prices decreased to $88 per share, thus erasing all the profits and creating a loss of $2 per share.

Special Cases

In various countries, business entities’ calculation of book value is for taxation purposes. Accordingly, book value is treated as taxable income, and a specific rate applies to the book value to calculate the amount of taxes payable.

We are discussing the two major scenarios where the use of such profits is for taxation purposes:-

#1 – MAT for Companies in India

MAT or Minimum Alternative Tax applied to companies that pay dividends to their shareholders but do not pay taxes under normal Income tax provisions due to various exemptions and deductions allowed.

We calculate MAT using book profits. Here, it arrives after useful additions or deductions are made to net profit, as shown in the profit and loss statement.

#2 – Partnership Firm

In this case, it simply means the profits are computed before the partner’s remuneration. In other words, It is calculated by adding back the salary and commissions paid to the partners (if debited in the P&L account) into the net profit as per profit and loss account.

This has been a guide to what book profit is and its definition. Here we discuss how to calculate book profit from cash profit and practical examples and explanations. You may learn more about accounting from the following articles –

  • Profit FormulaProfit FormulaThe profit formula evaluates the net gain or loss of an organization in a particular accounting period. It is computed as the difference between the total sales revenue and the overall expenses incurred by the company.read moreBook Value of DebtBook Value Of DebtThe book value of debt is the total amount the company owes, which is recorded in the company’s books. It is used in liquidity ratios compared to the company’s total assets to check if the organization has enough support to overcome its debt.read moreAccounting Profit vs Economic ProfitAccounting Profit Vs Economic ProfitAccounting profit refers to profits that are recorded in the books of accounts calculated by deducting all the explicit cost incurred. Economic profit refers to the profit which is calculated taking into consideration both explicit as well as implicit cost.read moreDepletion ExpenseDepletion ExpenseDepletion expense is the cost allocated on natural resources (like oil, natural gas, coal) when they have been extracted. It includes the purchase price or the cost of the resource, cost of rights and anything required for preparing it for suitable extraction of resources.read more