2.3.1 Profit

Question 1

Statement of comprehensive income

Answer 1

-summarises a business’ historic trading activity
(sales revenue) and expenses
- show if made a profit or loss over a time period.

Question 2

Profit

Answer 2

Difference between total revenue and total costs

Question 3

Why have different kinds of profit

Answer 3

If business not doing well

Use different kinds of profit to find out where issue is

Question 4

7 reasons Why does a business need profits

Answer 4

1. costs
2. dividends
3. financial stability
4. retained profit
5. corporation tax
6. performance
7. Reward for business owner

Question 5

Direct costs

Answer 5

Often variable costs

Cost of sales (just stock)

Question 6

Gross profit

Answer 6

Revenue - costs of sales (cost of goods sold)

Question 7

Expensese

Answer 7

Overhead or indirect costs all same

Question 8

Operating profit

Answer 8

Gross profit - fixed overheads

Question 9

Profit before tax

Answer 9

Operating profit - financing costs

Question 10

Corporation tax

Answer 10

Charged on operating profit as % flat rate

Question 11

Net profit/ profit for year

Answer 11

Profit before tax -tax

Question 12

Ratio analysis

Answer 12

• analysing financial performance
• compare 1 piece of accounting info with another

-profitability and liquidity ratios use data from SOCI and SOFP

Question 13

Why use ratios

Answer 13

compare different years and different companies

assess performance

Question 14

Profitability ratios

Answer 14

Measure performance a firms efficiency at achieving profit

• higher % = better
• relate profit to size of firm
• remember nature of business

Question 15

Gross profit margin

Answer 15

Gross profit divided by sales revenue x100

-ignores overheads, useful to asses control direct costs and ability to max sales

Question 16

Operating profit margins

Answer 16

Operating profit divided by sales revenue x100

Best method of measuring performance as no control over tax
Should be compared with other competitors in same market and over time

Question 17

Profit for the year (net profit) margin

Answer 17

Net profit divided by sales revenue x100

Question 18

Profitability ratios provide useful insights

Answer 18

• business making a profit is profit growing
• how efficient is business at turning revenues into profit
• is profit enough to justify investment into business
• how does profit achieved compare with rest of industry

Question 19

increase profits by

Answer 19

sales:
- increase quantity sold
- increase selling price

less vc:
-reduce variable cost per unit

less fixed costs:

• increase output
• reduce FC

all = net profit

Question 20

increase quantity sold

Answer 20

• higher sales vol = higher sales(selling price not lowered)= boost rev = higher profit
• better use of production capacity no FC rise
• higher market share
• depend on elasticity of demand
• EOS, boost profit and react to demand
• sales value fall if price fall to increase sales vol
• may not have capacity to sell more
• competitors will respond
• marketing effects fail e.g promotion doesnt = results
• FC rise (higher marketing)
• more costs to differentiate (reduce sppu)

Question 21

increase selling price

Answer 21

• higher selling price=higher sales (quantity doesnt fall)=increase rev, add value and reduce COS
• maximise value extract from customer
• customer perceive product as high quality
• no need for extra production capacity
• depend on price elasticity of demand
• is product necessary and loyal customer
• sales value fall, price rise = a bigger fall in quantity
• work customers loyal, still perceive product good value
• competitor respond - lower prices & customers switch

Question 22

reduce VCPU

Answer 22

• increase value per unit sold
• paying less to produce
• higher profit margin each item, produced/sold
• customer dont notice change in price
• if supplier persuaded to offer better prices(EOS), quality improved through lower wastage, operations = efficient
• lower input costs = lower quality inputs = more waste
• customer notice decrease in product quality
• fixed overheads could be still high

Question 23

profit margin improvement and methods:

Answer 23

• increase sales value per customer = more profitable, impulse good to just by check out
• cut wastage rates = order smaller quantities, avoid good going past sell by dates
• cut fixed overheads costs = move head office to smaller cheaper premises
• cut salary bill= dont replace leaving staff, ask remaining to work harder

Question 24

increase production output

Answer 24

• provide greater quality product to be sold = higher rev
• enable business maximise share of market demand
• spread fixed cost over greater no of units
• extra output sold = find new market, offer lower price for more basic product, if spare capacity
• stock perishable = lost rev if not sold
• dangerous option if no demand
• FC rise (stepped fixed costs)
• production quality compromised lower to produce more

Question 25

reduce fixed costs

Answer 25

-drop in FC = directly higher profits margins, reduce rent (smaller) & avoid cash flow issues
-reduces break even output
-substantial saving by cutting unnecessary overheads
-decrease sppu= profit increase and efficient with space
-provided costs cut dont affect quality/customer service
or output,most business always find savings in overheads
-reduce ability of business to increase sales
-intangible costs e.g. lower morale after redundancies
-reduce marketing costs = slow growth down

Question 26

revenue vs cash inflow

Answer 26

REVENUE: not same as money in, not same as ‘cash in’
value of sales made over a specified period
comes from one source, customers
-selling something on trade credit counts as revenue not cash e.g. cash doesn’t get paid straight away
cash less than revenue
e.g. credit sales made to customer

CASH INFLOW: can come from many sources, can be part of revenue e.g. bank loan
-source of finance = cash in not revenue e.g. bank loan appears as a cash inflow in cash flow statement
cash is greater than revenue
e.g. capital raised from selling shares, take out bank loan, carry out a sale and lease back

both: cash sales made to customer, charge rent on flat upstairs

Question 27

differences between net cash flow and net profit

how are cash flow and profit different concepts

Answer 27

1. timing differences (not receive cash straight away/delay cost payments)
2. way fixed assets accounted for (payment for asset= cash outflow vs cost of fixed assts = asset not cost)

• profit indicates amount of money left over after all expenses paid, cash flow indicates net flow of cash into and out of business
• can be making profit with negative cash flow

Question 28

receipts different from revenue

payments different from costs

Answer 28

revenues are amount it has earned as result of business activities (selling merchandise) vs company’s receipts refers to cash company received
e.g. borrowing $1,000 in cash from bank = receipt not revenue

costs are finance being used up or incurred in process of earning revenue and or operating a business, vs payment is disbursement of money (check/currency)

Question 29

difference between profit and cash flow accounts/ are constructed

how do timescale affect relative importance of cash vs profit

Answer 29

-cash accounts just money in - money out (only considers 1 variable) profit has to consider revenue and costs so can fluctuate more in accounts

may not receive cash straight away give credit of 30days but that sale will contribute to profit straight away
short term vs long term

Question 30

profit vs cash flow

Answer 30

PROFIT: accounted for less frequently
TR-TC over a period

CASH FLOW(SOF) : key in short term 
total cash inflows - total cash outflows over a period 

1. timing differences (sale to customer, paying supplier)
   profit long term, cash immediate
2. way non current assets accounted for (payment of asset= cash, value of asset= value not cost, depreciation of asset = cost)
3. cash flows arising from how business financed (cash inflow from selling share/loans/debt factoring, repay loans and paying dividends = cash outflows)

Question 31

opening and closing balance

Answer 31

opening: money at start of month
closing: money at end of month
(statement of comprehensive income)

Question 32

costs vs outflows:

Answer 32

-some outflows not shown in COS or fixed overheads
e.g. financing costs, dividend paying, corporation tax
(business may have OP not cash)
cause of this: overtrading
profitable business can/often fail as run out of cash

e. g. buy good on credit= Profit;sales recognised, Cash flow inflow when customer pays
e. g. marketing= Profit from marketing costs, Cash outflow when pay agency
e. g. machinery bough = Profit no effect add to fixed asset value, Cash: outflow paid to supplier
e. g. depreciation of fixed asset= Profit depreciation value included as a cost, Cash no effect

Question 33

overtrading

Answer 33

trying to expand too quick = cash flow issue

Question 34

3 accounts

Answer 34

Statement of comprehensive income (PAST)
Statement of financial position (PRESENT)
Cash flow forecast (FUTURE)