2.3.1 Profit

Question 1

Define ‘profit’

Answer 1

• Profit is the money left over after all costs have been accounted for

Question 2

What are the 3 different types of profit?

Answer 2

• Gross Profit
• Operating Profit
• Net Profit

Question 3

What is gross profit?

Answer 3

• The difference between revenue & the costs directly related to production

Question 4

What is operating profit?

Answer 4

The difference between the gross profit & the indirect expenses involved in operating the business

Question 5

What is net profit?

Answer 5

• The difference between the operating profit & any interest paid & recieved, as well as many one off costs

Question 6

What is the formula for gross profit?

Answer 6

Revenue - Costs of sales

Question 7

What is the formula for operating profit?

Answer 7

Gross Profit - Operating Expenses

Question 8

What is the formula for net profit?

Answer 8

Operating Profit - (net interest + exeptional costs)

Question 9

What’s the formula for profit of the year after tax?

Answer 9

Profit for the year - Tax

Question 10

What is a profit margin?

Answer 10

The amount by which the sales revenue exceeds the costs

Question 11

How do you work out the gross profit margin?

Answer 11

Gross profit/Revenue X100

Question 12

How do you calculate the operating profit margin?

Answer 12

Operating Profit/Revenue X100

Question 13

How do you calculate the net profit margin?

Answer 13

Profit for the year/Revenue X100

Question 14

What ways are there to improve profitability?

Answer 14

• Increase Prices
• Reduce variable costs e.g. purchase in bulk, buy cheaper stock, change packaging
• Reduce expenses e.g. relocate the business,reduce staffing levels, replace inefficient fixed assets
• Reduce one-off costs and interests e.g. implement zero budgeting, lease fixed assets,restructure borrowing

Question 15

If a business raises its prices how will it improve profitability?

Answer 15

• The difference between the selling price & costs is now greater

Raising prices is likely to have an impact on demand so businesses must understand the price elasticity of demand for its products

Where demand for products is price elastic, increasing prices will result in lower revenue - in this case, profitability will be reduced

Where demand for products is price inelastic, increasing prices will increase revenue - in this case profitability will rise

Question 16

If a business reduces its variable costs how will it improve profitability?

Answer 16

• May involve purchasing cheaper/alternative resources, negotiating with suppliers or purchasing in bulk

Businesses must ensure that reducing variable costs will not have an adverse effect on the quality or desirability of products

Buying stock in greater quantities may require investment in increased storage space, which will reduce the impact of the cost savings made

Businesses may also be able to reduce waste of raw materials & components

Question 17

How will reducing other expenses increase profitability?

Answer 17

• Reducing staffing levels, relocating to cheaper premises or changing utility companies can reduce expenses

Reducing staffing levels may affect staff morale & negatively affect productivity

Relocation costs can outweigh some benefits of moving to a cheaper location

Replacing inefficient or outdated equipment may require staff training

Question 18

How will reducing one off costs & interest charges increase profitability?

Answer 18

• Delaying the purchase of fixed assets, entering leasing arrangements, or restructuring borrowing can reduce costs

Delaying purchases of new fixed assets (e.g. machinery or vehicles) may negatively impact capacity utilisation as a result of increased breakdowns & maintenance of the old equipment

The leasing of equipment (e.g. photocopiers) can reduce one-off purchase costs but the business never owns these assets, which weakens the balance sheet

Restructuring borrowing can result in lower monthly payments but requires lenders to agree to new terms, which they may not be willing to do

Question 19

What is the distinction between profit & cash?

Answer 19

• Profit is simply the difference between revenue generated & business costs

Cash is measured by taking into account the full range of money flowing in & out of a business

A new business may have to pay cash on purchase for all supplies until good business relationship has built up level of trust w suppliers
Supplier may then give the business trade credit of 30 or 60 days
Means that the business can receive their stock now & only pay for it in 30 or 60 days, so the cash outflow is delayed

**A profitable business is likely to fail if it does not have sufficient cash

Cash-poor businesses will struggle to pay suppliers**