The measurement and importance of profit

• Price is the amount paid by a consumer to purchase one unit of a product
• Price should be set high enough to cover costs and leave enough for a surplus profit, however if the price is too high and above that of a competitor, this might put customers off
• Total revenue is the income gained from an organisations activities
• Revenue = Price x Quantity sold
• Total revenue might also be defined using the following terms

  • income
  • revenue
  • sales revenue
  • turnover
  • sales turnover
• Total revenue can be calculated by multiplying the average selling price by the total quantity sold
• Ways to improve revenue

  • increase selling price
  • increase quantity sold
• Fixed costs are costs that do not vary directly with output or production and normally stay the same for a year or more
• Variable costs are costs that very in direct relation to output
• Semi-variable costs are costs that combine elements of fixed and variable costs
• The contribution per unit is the difference between the sales revenue per unit and the variable cost per unit
• Break even point (BEP) is when total revenue equals total costs, so there is no profit or loss.
• Total costs are the sum of all the fixed and variable costs
• Total costs = Fixed costs + Variable costs
• To assess the impact of changes in output on the costs of production a business can look at the additional sales revenue gained if they were to increase output and see if it exceeds the extra costs incurred
• To calculate the costs of making a particular product it is important for a business to calculate the costs of making a product as this can help with determining price or identifying areas where costs need to be reduced
• Effects of changes in output on costs

  • should always assume the variable costs will rise by the same percentage rate as output
  • fixed costs will not change if output changes
• The average cost of production is the total costs of production divided by the level of production or output to give the cost of producing a single unit of output
• Average cost = Total costs / Output
• Costs are used to determine price
• In many industries, if costs rise such as raw materials and labour, the increase in cost is passed on to the customer through a price rise. However a rise in price is likely to see a fall in demand - unless all businesses in the industry are raising prices at the same time
• Profit is the difference between the total revenue of a business and its total costs
• Profit = Total Revenue - Total Costs
• There are two ways to increase profit

  • increase sales revenue
  • decrease costs
• Profit is important as it is a prime objective for most businesses (motivation)
• Profit is a reward - business owners take a risk when starting a business, the profit is the reward for this risk
• Profit is a motivator - in some businesses managers and employees are given a share of the profit to reward them for their efforts
• Profit is a measure of success - it is possible to assess performance by comparing profit figures with similar businesses
• Profit is a guide for future investment - good/rising profit levels might attract more investors to the company
• Profit is a source of finance - can be used to fund expansion plans and investment in the company
• Profit is attractive to stakeholders - for example workers might be more likely to apply for jobs in profitable businesses