2.4.1 Business Calculations

Question 1

Gross profit:

Answer 1

the profit that a business makes on its trading activity before any indirect costs have been deducted

Question 2

How is gross profit calculated?

Answer 2

gross profit = sales revenue(or turnover) - cost of sales (the cost of buying producing and distributing products and services)

Question 3

Net profit:

Answer 3

• aka the bottom line
• the profit that the business is able to return to shareholders or reinvest back into the business

Question 4

How is net profit calculated?

Answer 4

net profit = gross profit - other operating expenses and interest

Question 5

How can a business improve their profit?

Answer 5

• lowering costs
• increasing revenue

Question 6

What problems can a business improving their profit cause?

Answer 6

• the problem with increasing revenue is that the methods used can also increase costs
• the problem with lowering costs is that doing so can detract from the value of the product or service, reducing the business’s ability to make revenue

Question 7

Profit margin:

Answer 7

a profit margin is the ratio of profit compared to sales revenue - give an indication of a product’s profitability

Question 8

How do you calculate gross profit margin (GPM)?

Answer 8

gross profit margin (%) = (gross profit / sales revenue) x 100

Question 9

What does gross profit margin (GPM) indicate?

Answer 9

• the GPM indicated the proportion of sales revenue turned into gross profit
• e.g. 40% GPM indicated that 40p in every £1 of sales become gross profit

Question 10

How do you calculate net profit margin (NPM)?

Answer 10

net profit margin = (net profit / sales revenue) x 100

Question 11

What does net profit margin (NPM) indicate?

Answer 11

• the NPM indicates the proportion of sales revenue turned into net profit
• e.g. 8% NPM indicates that 8p in every £1 of sales becomes net profit

Question 12

How do you calculate average rate of return (ARR)?

Answer 12

average rate of return (%) = (total profit / no. of years))/cost of investment x 100

Question 13

What does average rate of return (ARR) indicate and what is it used for?

Answer 13

• a business will calculate the ARR that it receives on an investment over the investment’s life span as a % of the initial cost of investment
• the calculation is used to compare different investment opportunities to identify which is the most profitable