Are reinvested profits still “profits”?

Question

Let's say I run a restaurant for a quarter and the cost of a served meal includes the ingredients, service labor, and utilities and monthly mortgage payment for the restaurant building, totaling $8.40. I charge $15 for each meal, and thus my profit margin might be said to be $6.60, or 44%. For the quarter, if my sales totalled $40,500, or 900 monthly meals served, then would it be true that my earnings were 0.44*$40,500(=$17,820)?

But suppose that I was commencing an expansion initiative in the quarter with a $10,000 down payment for a new branch of my restaurant, would that reduce my quarterly profit from my $17,820 earnings to only $7,820?

Answer 1

It depends what you’re spending the money on. If it’s running costs, like salaries, rent and consumables, then it’s taken off your profit. If it’s tangible assets like equipment then it isn’t, because you still have the equipment and it still has value, but you depreciate it over time and take the depreciation off your profit. If it’s intangible assets like brand-building and software development, it’s more complicated.

Answer 2

"Profit margin" is not the same as "taxable profit."

When calculating your profit for tax purposes, you start with your gross revenue and then subtract your business expenses. You mentioned a per meal cost of $8.40, but this number is only an average/estimate of your actual expenses, useful for determining your pricing and profit margin, but not useful for calculating taxes. At tax time, you look at your actual revenue and expenses for the entire year.

Using your example numbers, let's say that your sales for the year were $162,000. On your taxes, you would declare all your deductible expenses. The cost of food is deductible, as is the payroll for your employees and utilities. Things like advertising are also deductible.

However, when you spend money on assets that have value and are intended to last for multiple years, you generally cannot deduct the expense in a single year. Instead, you have to do something called capitalization, where you spread the expense deduction over multiple years. If the value of the equipment depreciates, you deduct more of the expense from your profit over time.

As a result, your mortgage payment is not directly a deductible expense. The interest portion of it is, but the amount you pay on principal is not, because you are paying for the asset that is a building. Instead, you depreciate the building over several years and deduct the depreciation from your revenue. Restaurant equipment is depreciated the same way.

So for your $10,000 expansion, no, you will not be able to deduct all of it in a single year. The amount spent on assets (buildings and equipment with value) will need to be capitalized and depreciated.