What it means
Many non-finance managers get confused between profit that exists on paper and profit that is actually realised. When you own something like property, equipment, or shares, its market value changes constantly.
If the value goes up, you have an unrealised gain. However, you cannot spend this money or pay bonuses with it because the asset has not been sold.
Realised profit only happens when you finalise a sale and exchange the asset for cash or other liquid funds. This distinction matters greatly for day-to-day business management and tax purposes.
Governments typically do not tax you on paper gains because those values can disappear just as quickly as they appeared. They tax realised profits because the transaction confirms the financial gain.
For managers, relying on unrealised profits to make operational decisions or budget for future projects creates serious cash flow risks. In daily practice, your accounting profit and loss statement tracks your realised profits from selling goods and services.
If you manufacture a product for $10 and sell it for $15, that $5 profit is realised the moment the customer pays. Keeping track of this ensures you know exactly how much cash is available to reinvest in the business, pay dividends, or save for future growth.
Understanding the boundary between the two profit types helps you avoid overestimating your financial health. A company might look wealthy on paper due to rising asset values, but if those assets are not sold, the business might still struggle to pay monthly bills.
Prioritising realised profit keeps your business grounded in actual cash realities rather than speculative hopes. Imagine you own a rare comic book.
If a price guide says it is worth $100, that is an unrealised gain. You only have real money when you walk into a comic shop, hand over the book, and take the $50 in cash they offer.
In practice
Real-world examples
Example 1
You buy office furniture for $2,000. Two years later, a competitor offers to buy it for $1,500 and you accept. This is the reverse case: a realised loss of $500, which reduces your total realised profit for the year.
Example 2
Your retail shop holds surplus stock that originally cost $4,000. You run a clear-out sale, generating $6,000 in cash. You have realised a profit of $2,000 on the inventory, and because the customers paid at the till, the cash is already in your bank account.
Example 3
An independent software firm holds shares in a technology partner that double in value to $20,000. The firm sells the shares and receives the cash, securing a realised profit of $10,000. Before the sale the $10,000 was only a paper gain that could have vanished if the share price had fallen.
Think of it
Imagine you own a rare comic book. If a price guide says it is worth one hundred pounds, that is an unrealised gain. You only have real money when you walk into a comic shop, hand over the book, and take the fifty pounds of cash they give you.
Formula
Calculation
Realised Profit = Selling Price - Original Cost Price - Selling Costs.
Worked example: the selling price is $1,200 and the original cost price is $800. The realised profit is 1,200 - 800 = $400. This means you have $400 of actual profit recorded from the completed sale.
Now include costs of sale. If you pay a $50 commission to an agent to complete the same sale, the realised profit becomes 1,200 - 800 - 50 = $350. As a margin on the selling price, that is 350 / 1,200, or about 29%.Case study
Seen in the real world
This is a fictional, illustrative scenario. GreenLeaf Landscaping purchased a commercial lawn mower for $5,000 three years ago. Recently, local demand for landscaping equipment surged, and a neighbouring firm offered $7,000 in cash for the used mower. GreenLeaf accepted the offer and handed over the equipment.
On their financial records, the company recorded a sale price of $7,000 and subtracted the original cost of $5,000. This generated a realised profit of $2,000. The managing director made the mistake of thinking this meant the business had $2,000 in extra cash to spend immediately on a staff party. The company accountant quickly pointed out that while the profit was realised and taxable, a portion of the cash was needed to replace the mower for ongoing operations, reminding the team to view profits in the context of total business needs.
The accountant walked through the cash picture. The business received $7,000 from the sale, but a replacement mower cost $6,500, so only $500 was left from the proceeds. After setting aside tax on the $2,000 profit, the true spare cash was smaller still, which ended the idea of a party.
Watch out
Common mistakes
- Treating unrealised gains on investments as available cash to spend on business expenses.
- Failing to account for transaction fees and taxes when calculating the final realised profit.
- Confusing revenue collected with realised profit, forgetting to subtract the original cost of the sold item.
Questions
People also ask
Is realised profit the same as cash flow?
Not always. While realised profit means a transaction has finished, if the customer bought on credit, you might not have the physical cash in your bank yet.
Why do accountants separate realised and unrealised profits?
Because asset values fluctuate constantly. Separating them prevents businesses from paying taxes or spending money on gains that might vanish tomorrow.
Do I pay tax on unrealised profits?
Generally no. Tax authorities usually only tax profits once they are realised through a completed sale or exchange.