Measuring And Increasing Profit

Question 1

Gross profit

Answer 1

This is calculated by subtracting only variable costs from sales revenue, ignoring fixed costs.

Gross profit = Sales revenue - variable costs

= gross profit/sales revenue X 100

Question 2

Net profit

Answer 2

This is calculated by subtracting total costs from sales revenue.

Net profit = Sales revenue - Total costs

Net profit/sales Rev x 100

Question 3

Return on capital

Answer 3

The proportion that the net profit is of the capital invested in the business or project.

= Net profit/capital invested X 100

The higher the ratio the more profitable the investment has been - and it could also indicate the efficiency of the management in managing the investment.
Can be used to compare with other businesses in same industry.
Useful if a business needs to decide between two projects it may choose the one with the higher return on capital. When rival companies are making a higher return on capital then this indicates that profitability is falling behind Tay of competitors.

Question 4

The return on capital on a project or a new business proposal could be increased by either:

Answer 4

A) trying to increase profitability without investing any more capital.

B) Attempting to make the same level of profit but with less capital expenditure.

Question 5

Methods of increasing profit:

Answer 5

1. Increase sales - without reducing the net profit margin.
2. Increase net profit margin by reducing variable costs per unit.
3. Increase net profit margin by increasing price.
4. Increase net profit margin by reducing fixed costs.

Look at Table 18.1 on page 127 for limitations of these methods.

Question 6

Profit margin

Answer 6

The profit made as a proportion of sales revenue.