Business 2.3.1 Profit: Managing Finance

• What is the definition of gross profit?

  The difference between the sales revenue of the business and the cost of sales of the business
• What is the calculation for Gross Profit?

  Revenue - Total costs
• What are costs of sales?

  The total cost of directly producing or buying the goods / services sold in a period ( Direct cost of a business’ sales )
• What is the definition of Operating Profit?

  Difference between the gross profit of the business and the overheads of the business
• What are the calculations for Operating Profit?

  Gross Profit - other operating expenses

  Sales revenue - ( cost of sales + other operating expenses )
• What does operating profit consider?

  The indirect costs of a business. i.e the costs not directly involved with producing / buying goods / services sold in a period
• What is the definition of Profit for the year ( Net Profit )?

  Difference between operating profit and interest
• What are the calculations for Profit for the year ( Net Profit )?

  Operating profits - interest

  Sales revenue - ( costs of sales + operating expenses + interest )
• What is Profit for the year ( Net Profit ) referred to as?

  The ‘bottom line’ and is the profit that is left for the owners after all the costs have been deducted
• What is the calculation for Profit?

  Total revenue - Total costs
• What is a statement of comprehensive income ( profit or loss account ) ?

  A key financial statement and shows the income and expenditure of a business during the previous financial year
• What 3 key ratios can be calculated to measure the profitability of a business?

  • Gross Profit margin = how much gross profit is being made for every £1 sale
  • Operating Profit margin = how much operating profit is being made for every £1 sale
  • Profit for the Year ( Net Profit ) margin = how much net profit is being made for every £1 sale
• What is the calculation for Gross Profit margin?

  Gross Profit / Revenue = x 100
• A higher Gross Profit margin is seen as better than a low Gross Profit margin, but it’s important to compare with similar businesses as well as from previous years.

  EG. A falling Gross Profit margin could indicate that supplier costs are rising and / or the business is selling at lower prices
• What is the calculation Operating Profit margin?

  Operating Profit / Revenue = x 100
• • A higher Operating Profit margin is better than a low Operating Profit margin, but it’s important to compare with similar businesses as well as from previous years, to see if it is increasing or declining
  • EG. an increasing Operating Profit margin means that the business is becoming more efficient and managing its operating expenses / overheads better
• What is the calculation for Profit for the Year ( Net Profit ) margin?

  Profit for the Year ( Net Profit ) / Revenue = x 100
• • A higher Profit for the Year ( Net profit ) margin is better than a low one, but it’s important to compare with similar businesses as well as previous years to see if it is declining or increasing
• What are the ways to improve profitability?

  • Increase quantity sold
  • Increase selling price
  • Reducing Variable Cost per unit
  • Increase Production Output
  • Reduced Fixed Costs
• Increase quantity sold:


  WHY? = higher sales volume which can lead to higher sales revenue ( assuming the selling price is not lowered )

  WILL IT WORK? = depends on elasticity of demand and there could be a fall in sale value if price is reduced for higher volumes and does the business have the capacity to sell more?

  WILL IT NOT WORK? = Competitors will respond and marketing efforts may fail EG. Promotional campaigns won’t generate sales
• Increase selling price:

  WHY? = Can lead to higher sales revenue and the quantity sold doesn’t fall in response and it maximises value extracted from customers and the product receives the perception that it is of high quality and there is no need for extra production capacity

  WILL IT WORK? = Depends on elasticity of demand and if customers remain loyal and if the product has a good value because with a price rise, less quantity may be sold and sail value may fall

  WHY IT MIGHT NOT WORK? = Competitors will respond and Customers may switch
• Reducing Variable Cost per unit:

  WHY? = Increases value added per unit sold and there is a higher profit margin on each item and customers don’t notice the price change

  WILL IT WORK? = Yes if suppliers are persuaded, quality is improved and operations are organised

  WHY IT MIGHT NOT WORK? = Lower input costs = low quality inputs = greater wastage and customers may notice quality decrease
• Increase Production Output:


  WHY? = Greater product quantity and can maximise share of market demand and can spread Fixed Costs over a number of units

  WILL IT WORK? = If extra output can be sold and the business has spare capacity

  WHY IT MIGHT NOT WORK? = What if the demand is not there? Fixed Costs may rise and Quality may be lowered to produce more
• Reduced Fixed Costs:


  WHY? = Reduces Break Even output and savings are made by cutting unnecessary overheads and directly into higher profits

  WILL IT WORK? = Provided costs don’t affect quality, customer service or output and you can always find savings in overheads

  WHY IT MIGHT NOT WORK? = May reduce ability to increase sales and with intangible costs it may lower morale after making redundancies