2.4

• Gross profit = sales revenue - cost of sales
• Cost of sales is also known as "cost of goods sold" and includes direct costs of manufacturing or costs of buying in the stock
• Gross profit is the profit after paying all the direct costs
• Direct costs include raw materials, ingredients and stock
• Gross profit tells us how effectively they control their direct costs and if they add enough value
• Net profit = Gross profit - operating expenses
• Operating expenses include all the indirect costs associated with running the business, this may include rent, advertising, managers salaries, interest on loans etc
• Net profit is the profit after paying all the costs
• Net profit tells us how well the business manages its indirect costs
• Gross profit margin = (Gross profit/sales revenue) x 100
• The gross profit margin indicates the proportion of sales revenue turned into gross profit. It indicates how well a business is controlling their direct costs. The gross profit margin can be increased by increasing the price and/or reducing cost of sales
• Net profit margin = (net profit/sales revenue) x 100
• The net profit margin indicates the proportion of sales revenue turned into net profit. The net profit margin is considering all costs. A business with a large gross profit and a small net profit is not controlling here indirect costs well
• Average rate of return = (average annual profit/cost of investment) x 100
• ARR allows businesses to see how risky an investment is and whether it is worth taking, the calculation can be used to compared different investments to identify which one gives the best return i.e/ is most profitable on average over the investments lifespan