Business calculations

• It is important to understand the difference between gross and net profit in business
• Businesses usually separate their costs into variable costs (expenses that change directly with output, e.g., raw materials) and fixed costs (expenses that do not change with output, e.g., rent)
• Gross profit is the difference between the money received from selling goods and services and the cost of making or providing them, ignoring any fixed costs or overheads
• Sales revenue is the money received from selling goods and services, while the cost of making the goods or providing the services is called the cost of sales
• To calculate gross profit, a business uses the formula: Gross profit = sales revenue − cost of sales
• For example, if a business sells 10,000 bottles of water per day at £0.99 each, with variable costs of £0.49 per bottle, the gross profit per bottle is £0.50, totaling £5,000 per day
• In the given question, if a supermarket sells £100,000 worth of products in a week and it cost £28,000 to buy those products, the gross profit made that week is £72,000
• Net profit is calculated by deducting all expenses from gross profit and represents the difference between the money received from selling goods and services and all costs incurred
• Net profit is considered more important than gross profit as it includes fixed costs and overheads, indicating the actual profit made by a business
• Net profit can be negative, showing that a business has made a loss when its costs exceed its sales revenue
• To calculate net profit, a business uses the formula: Net profit = gross profit − other operating expenses and interest
• In a given example, a biscuit factory makes a loss of £12,500 during the year when considering all costs incurred
• Gross profit margin is the percentage of sales revenue that is left once the cost of sales has been paid
• It tells a business how much gross profit is made for every pound of sales revenue received
• To calculate the gross profit margin, a business uses the formula: Gross profit margin (%) = (Gross profit / Sales revenue) x 100
• Comparing gross profit margins over time can help businesses assess their performance and make decisions based on cost and revenue changes
• In the example provided, the gross profit margin decreased despite the sales revenue tripling and gross profit doubling, indicating that the cost of sales increased faster than the price charged to customers
• Businesses may respond to a decreasing gross profit margin by increasing prices or negotiating lower costs with suppliers
• Net profit margin is the proportion of sales revenue that is left once all costs have been paid, calculated as \(\text{Net profit margin (\%)}=\frac{\text{Net profit}}{\text{Sales revenue}}\times100\)
• Net profit margin indicates how much net profit is made for every pound of sales revenue received
• In competitive markets like food retail, net profit margins can be very small
• Businesses can use the net profit margin to identify changes in fixed costs by comparing it with the gross profit margin or by comparing net profit margins over time
• For example, a decrease in net profit margin could indicate that sales revenue has fallen faster than costs or that costs have increased faster than sales revenue
• In a given example, a self-employed plumber made the same net profit in two years but was able to reduce costs in the second year despite lower sales revenue
• It is important to understand the difference between gross and net profit in business decisions
• Knowing the gross profit margin, net profit margin, and average rate of return is essential when making business decisions
• The average rate of return is a method of comparing the profitability of different choices over the expected life of an investment
• To calculate the average rate of return, a business uses the formula: Average rate of return (%) = (Average annual profit ÷ Cost of investment) × 100
• In a scenario where a business is deciding between extending its existing factory or moving to bigger premises, the option with the higher average rate of return is the better financial decision