2.3.1 Profitability Flashcards
profit
the difference between the revenue of a business and the costs generated by the business during a period of time
profitability
the efficiency with which a business is able to make profits
profit equation
total sales (revenue) - total costs (VC + FC)
name the types of profit
gross profit (GP)
operating profit (OP)
net profit (NP)
gross profit
-difference between revenue and costs directly related to production
revenue - costs of sales (VC)
operating profit
-difference between gross profit and the indirect expenses involved in operating the business (fixed costs)
gross profit- operating expenses
net profit/ profit for the year
-difference between the operating profit and any interest paid and received, plus any one off costs
operating profit- (net interest+ exceptional costs) e.g. tax
The Statement of Comprehensive Income
an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months
what is a profit margin?
the amount by which the sales revenue exceeds the costs
-can be calculated for each type of profit
what margins are preferable for a business?
higher and increasing profit margins- means more revenue is being converted to profit
-as they can be compared to previous years to better understand business performance
gross profit margin
(equation)
shows the proportion of revenue that is turned into gross profit as a %
= (gross profit/ revenue) x100
operating profit margin
(equation)
shows the proportion of revenue that is turned into operating profit and is expressed as a %
= (operating profit/ revenue) x100
net profit margin
(equation)
shows the proportion of revenue that is turned into net profit before tax and is expressed as a %
= (profit for the year/ revenue) x100
ways to improve profitability
-raising prices
-reducing variable costs
-reducing other expenses
-reducing one-off costs and interest charges
how does raising prices improve profitability?
if costs remain the same, this improves profitability, the difference between selling price and costs is greater
-PED is a factor
-need to have price inelastic demand for products to have increasing profitability
how does reducing variable costs improve profitability?
may involve purchasing cheaper resources, negotiating with suppliers or purchasing in bulk
-need to ensure quality or desirability of products stays the same
-buying in bulk will need more storage space
how does reducing other expenses improve profitability?
reducing staffing, relocating to cheaper premises or chaging utility companies can reduce expenses
-can affect staff morale, productivity
-relocation costs
-staff training
how can reducing one-off costs and interest charges improve profitability?
delaying purchase of fixed assets, leasing can reduce costs
-can negatively impact capacity utilisation as a result of increased breakdowns and maintenance of the old equipment
-leasing things can reduce one off purchase costs, but they are not an asset- weakening balance sheet
describe the distinction between profit and cash
profit is the difference between revenue generated and business costs
cash is measured by taking into account the full range of money flowing in and out of a business
- a new business may have to pay cash on purchase for all supplies
- a profitable business is likely to fail if it does not have sufficient cash
how can reducing product range increase profit?
if a business has too many products or some products are too complex to make, and too expensive, to produce making low margins, it may be worth discontinuing them, to increase margins
how can outsourcing non-essential functions increase profit?
-this reduces fixed costs
-allows the business to focus on what it is best at
-e.g. making telephone handling system automated instead.
