3.5 - Analysing Financial Performance Flashcards
What are the 4 different types of profit? How are they calcualted?
In general profit = total revenue - total costs
GROSS PROFIT
sales - cost of sales
NET PROFIT aka opersating profit (profit from operations-before tax, interest etc)
gross profit - expenses
PROFIT FOR THE YEAR (profit left to reinvest/pay out to shareholders)
net profit - all other costs (interest, tax etc)
What are profit margins? How are they calculated?
Profit as a percentage of sales revenue (proportion of sales revenue leftover as profit after costs)
Profit margin = (profit/sales revenue) x 100
Can be calculated for gross or net profit
What are the 2 other types of profit margin? How are they calculated?
GROSS PROFIT MARGIN
- (gross profit/sales revenue) x 100
- A measure of a company’s profitability
OPERATING PROFIT MARGIN aka net profit margin
- (operating profit/sales revenue) x 100
- Sales after VC but before interest, tax etc
What is the difference between profit and profitability?
Profit is an absolute number
Profitability is a relative measure where comparisons are made and show the extent to which profit has been made
What does cost of sales include?
Direct costs - paid to make/provide goods/service
VARIABLE COSTS
Eg/ stock, raw materials
What does a higher gross profit margin show?
The more a business has added as a mark up on the cost to produce
To fully analyse have to compare to similar brand/previous figures
Suggests strong brand
How can gross prfit be improved?
Need to increase gap between sales revenue and direct costs, so
- increase prices
(depends on elasticity-will this keep/lose customers) - decrease costs
(switch suppliers-service/quality implications)
(reduce wastage-make it right first time)
(better bargaining with suppliers-long term/bulking deals)
Which figure is revews and assessed by shreaholders?How coudl this margin be improved?
Net/operating profit
TO IMPROVE
- increase selling price
- decrease costs (direct and overheads)
How can overhead costs be reduced?
Fewer staff
Remove least effective advertising
Reduce wastage
Outsourcing - get another company to do some of your work for you eg/cleaning
How can profit and profitability increase?
PROFIT
- spend more in advertising, expand product range, change prices
- decrease costs
PROFITABILITY
- reducing costs, increasing turnover, increasing productivity, increasing efficiency
What are 2 ways to measure profitability?
GROSS profit margin
NET/operating profit margin
Explain the drawbacks of improving profits through making staff redundant, reducing employee wages, moving to a cheaper location, changing to a cheaper supplier and increasing prices
Making staff redundant
- demotivation of staff-worry about job security
- could impact service level
Reducing employee wages
- demotivation
- slower work rate, industrial action (strike), higher proportion leave
- service level impacted
Moving to a cheaper location
- initial cost to do it
- could be less footfall due to being less convenient
- transport, environment and ethical issues if moving abroad
Changing to a cheaper supplier
- quality issues-impacts reputation and sales
Increasing prices
- impact depends on elasticity (balance has to be right-still a change if slightly inelastic)
What is contribution? How is contribution per unit and total contribution (analytic method) calculated?
Amount of money after VC of production has been paid-if it exceeds FC, business is making profit (firm breaks even when total cpntributio or total revenue=total costs)
1 Contribution PER UNIT
Selling price - variable cost per unit
2 TOTAL contribution
Sales revenue - total variable costs
How is break even output calculated?
What is break even output? What are the factors affecting it?
Fixed costs / (selling price -variable cost)
level at which total sales revenue is equal to total costs of production
FACTORS
- changes to selling price
(eg/ higher selling price-increase effect on contribution, lower effect on break even output)
- changes to fixed costs
(eg/ increase in fixed costs-effect on contribution stays same, effect on break even output increases-needs to sell more) - changes to variable costs
(eg/ higher variable costs-decrease effect on contribution, increase effect on break even output)
What is break even analysis? What are the 2 strengths and 2 limitations?
Study of relationship between TC and TR to identify level of output at which business breaks even (no profit,no loss)
+ focuses on what output is required before business reaches profitability
+ helps management and finance providers better understand viability and risk of business or idea
- variable costs do not stay the same
- a planning aid rather than a decision making tool
