How are profit and loss calculated?

It is August. Sherali aka sells watermelons by the roadside. One week he came home happy in the evening, but the next week he was upset. The watermelons were the same, and so was the price. So what changed? Two words give the answer: profit and loss.

What are profit and loss?

In the fifth lesson we saw that income is money that comes in, and expenses are money that goes out.

• If income is larger than expenses, the part left over is profit.
• If expenses are larger than income, the part that is missing is a loss.

The calculation is always the same: income − expenses. If the result is positive, it is a profit. If it is negative, it is a loss.

Sherali aka's two weeks

For example (the figures are hypothetical). Every week Sherali aka buys 100 watermelons from a farmer at 15 000 soum each. He pays 200 000 soum for a truck to bring them. At the market he sells each watermelon for 20 000 soum.

In the first week the weather was hot, and all 100 watermelons were sold.

In the second week it rained. 70 were sold at the usual price. 10 cracked and went rotten. He sold the remaining 20 at half price, 10 000 soum each.

Expenses are the same in both weeks. Income made the difference: fewer watermelons were sold, some went cheap, and some were not sold at all.

How much is left from one watermelon?

Many people think: "a watermelon is 20 000 soum, so that is 20 000 soum of profit". This is a mistake.

How much does one watermelon cost Sherali aka? 15 000 soum for the watermelon itself, plus the truck money: 200 000 ÷ 100 = 2 000 soum. In total 17 000 soum. When he sells it, 20 000 − 17 000 = 3 000 soum is left in his hand. From 100 watermelons: 3 000 × 100 = 300 000 soum. Exactly the profit of the first week.

So the whole price is not profit. Profit is the difference between the price and "how much it cost him" (the cost from the third lesson).

Where does a loss come from?

In Sherali aka's example we saw three causes of a loss:

1. things were not sold;
2. things went bad;
3. things were sold cheaper than they cost.

Even if one of these happens, profit goes down. If all three happen together, profit turns into a loss.

How can a loss be reduced?

The weather forecast said there would be more rain. That week Sherali aka bought 80 watermelons instead of 100. The truck money did not change.

• Expenses: 80 × 15 000 + 200 000 = 1 400 000 soum.
• Because there were fewer watermelons, none had time to rot: 70 were sold at 20 000 soum, and the remaining 10 at 10 000 soum: 1 400 000 + 100 000 = 1 500 000 soum.
• Result: 1 500 000 − 1 400 000 = profit 100 000 soum.

The weather was the same, but he did not buy extra watermelons, and instead of a loss there was a small profit. Thinking in advance about how much buyers will take is a trader's most important habit.

In the next lesson

In the seventh Basics lesson we will talk about what belongs to a person: what ownership and property are.