Measuring Financial Performance With Gross Margins. Flashcards
What is Profit(Loss)?
Profit (Loss) = Income – Expenses
What is Profitability?
Makes reference to the level of assets used in generating the profit.
Profitability = Profit /Asset Value
What are Expenses?
- Expenses are sum of fixed and variable costs
- Total costs = Variable costs + Fixed costs
- Profit (Loss) = Income - Variable cost - Fixed costs
What is a Variable Cost (Enterprise Costs)?
Variable costs (enterprise costs) are the costs that will occur only if production actually takes place, and tend to vary with the level of production.
What are Fixed Costs (Overhead Costs)?
Fixed costs (overhead costs) are the costs that will not change in the short run even if no production takes place.
What Is a Gross Margin?
• A measure of the financial performance or profit of a business.
• Examines the efficiency of use of variable costs.
• Difference between income and variable costs.
• Does not include fixed costs
Gross Margin = Income - Variable Costs
What is Total Gross Margin?
• Total Gross Margin = Operating Revenue - Variable Costs
• Net Farm Income (Loss) = Operating Revenue – Variable
Costs - Fixed Costs
• From the expression for Net Farm Income (Loss) above we could also express Total Gross Margin in these terms:
• Total Gross Margin= Fixed Costs + Net Farm Income (Loss)
• Total Gross Margin is the vital step in maximising profit in the short-term.
When To Use Gross Margins?
Evaluating changes to management Comparative farms
Adjusting enterprise mix
What is Evaluating Changes in Management?
changes to production strategies changes to marketing strategies changes to pricing strategies
What is meant by Comparative Farms?
• Used to measure on farm production efficiency
(operating efficiency comparisons between businesses).
• Fixed costs are not included due to the difficulty in allocating them to enterprises (i.e. fixed costs are excluded when interest is on production efficiency).
• Gross margin analysis can be used to highlight inefficient management practices compared to other properties.
What is Enterprise Mix (Enterprise Mix Decisions)?
- The resources of most business are sufficiently versatile to produce a number of products, eg. sheep, beef, crops. Management must select an enterprise or enterprise mix.
- The enterprise mix will often be selected with the goal of maximizing profit.
- Where an enterprise is already present the fixed costs will be incurred irrespective of the enterprise mix (in the short-run).
What are Limitations Of Gross Margins?
• Gross margins are not the correct toll for evaluating management changes that involve changes in the level of fixed costs.
• Do not include fixed costs and should not be used to compare enterprises with different capital requirements.
• Do not consider interactions, eg. crop rotations;
crop and animal interaction (eg. Australian wheat-sheep zone).
• Do not consider economies of size or economies of scale.
• Should not be used where the income or the costs are incurred through the time periods greater than 12 months (because of the time value of money).
What is meant by Sensitivity Of Gross margins To Key Parameters?
- Sensitivity analysis examines the impact of changes in values of key variables.
- Gives an idea of how robust the project is to changes in the key variables
- Breakeven is a special case of the sensitivity where the profit is zero.
What is Inflation (Deflation)?
- Inflation is an increase in the average price level of goods and services in the economy, measured using the Consumer Price Index (CPI).
- In business real means a value has been adjusted for inflation, but the actual value is nominal value.
What is Nominal Income?
Nominal income is the actual number of dollars received over a period of time.
