Paper profit - what is paper profit?
Paper profit, also known as book profit, is an increase in an investment’s value that appears in financial records, but that doesn’t involve an actual cash increase. An example could be when the value of shares rise, but they have not yet been sold.
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In this way, paper profit can be described as the unrealised capital gain of an investment. Profit is only realised when the investment position is closed, i.e. once there’s actual money that has been made.
How does paper profit work?
Paper profit refers to the not-yet-realised amount you gain on assets that you own. The asset has increased in its value, but this increase hasn’t yet translated into tangible profit. Paper profit is based on the spread between the asset’s current market price and its original purchase price.
For example, suppose you buy a share for £500. Later on, the current market price for this share has increased to £850. On paper, it’s now worth more than you originally bought it for. The paper profit is then £350 (£850 - £500 = £350). In this case, you can sell the share for more than you initially paid, meaning that the paper profit is actualised and you make a real profit.
This can also work in reverse, i.e. you can make a paper loss. This is when your asset decreases in value. You have a paper loss until you decide to sell the asset, and that loss is realised in the form of money.
Paper profit and capital gains tax
You don’t have to pay capital gains tax on paper profit. This is because capital gains tax is only paid when you actually sell the asset.
If you do decide to sell your assets, you have to consider additional fees and taxes you may be charged. You need to weigh up whether it’s still financially beneficial to convert a paper profit into actual gains after you have paid the additional costs that will cut into your profit.
How to account for paper profit when calculating your finances
You should use the paper value of your assets when you calculate the gains (or losses) in your investments. You should recognise that there is always a risk that you will lose the paper profit again before you have a chance to realise it. At the same time, it’s always possible that you could increase your actual profit by postponing selling your asset because you expect to see further increases in its value.
Why is paper profit important?
You can calculate the paper profit that’s held on any asset at any point. All you need to do is look at how much the asset is currently worth and compare that with what it initially cost you. The paper profit of your business assets is important because it can indicate to investors whether or not your business is valuable.
Most importantly, the paper profit you have is only actualised once you sell the security.
