2.3.1 Profit Flashcards
Define ‘profit’
- Profit is the money left over after all costs have been accounted for
What are the 3 different types of profit?
- Gross Profit
- Operating Profit
- Net Profit
What is gross profit?
- The difference between revenue & the costs directly related to production
What is operating profit?
The difference between the gross profit & the indirect expenses involved in operating the business
What is net profit?
- The difference between the operating profit & any interest paid & recieved, as well as many one off costs
What is the formula for gross profit?
Revenue - Costs of sales
What is the formula for operating profit?
Gross Profit - Operating Expenses
What is the formula for net profit?
Operating Profit - (net interest + exeptional costs)
What’s the formula for profit of the year after tax?
Profit for the year - Tax
What is a profit margin?
The amount by which the sales revenue exceeds the costs
How do you work out the gross profit margin?
Gross profit/Revenue X100
How do you calculate the operating profit margin?
Operating Profit/Revenue X100
How do you calculate the net profit margin?
Profit for the year/Revenue X100
What ways are there to improve profitability?
- 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
If a business raises its prices how will it improve profitability?
- 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
If a business reduces its variable costs how will it improve profitability?
- 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
How will reducing other expenses increase profitability?
- 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
How will reducing one off costs & interest charges increase profitability?
- 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
What is the distinction between profit & cash?
- 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**
What is a statement of comprehensive income? (Profit and Loss account)
- An end of year financial statement that shows all of a businesses income and expenses over the previous twelve months
- Each type of profit is calculated with the statement of comprehensive income
