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Understanding Business Profitability

The document discusses profit, defining it as the money remaining after all costs are met, and outlines the calculations for gross profit, operating profit, and net profit. It also describes the Statement of Comprehensive Income as a key document showing a business's financial performance and profitability measures like gross and operating profit margins. Additionally, it provides strategies for increasing profits through price adjustments and cost reductions.

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Safi BW
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8 views2 pages

Understanding Business Profitability

The document discusses profit, defining it as the money remaining after all costs are met, and outlines the calculations for gross profit, operating profit, and net profit. It also describes the Statement of Comprehensive Income as a key document showing a business's financial performance and profitability measures like gross and operating profit margins. Additionally, it provides strategies for increasing profits through price adjustments and cost reductions.

Uploaded by

Safi BW
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

CHAPTER 34: PROFIT

I. Profit
 is the money left over after all cost have been met & belons to the owners of the
business. Calculation of:
1. Gross profit - is the difference between revenue/sales revenue/turnover & cost of sales

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠


which are the direct costs of the business.

2. Operating profit - is the difference between gross profit & business overheads. Overheads

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠


are indirect costs, such as selling & administrative expenses.

𝑃𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟(𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡) = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 – 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡


3. Profit for the year (Net profit) -profit made by the business for the year.

II. Statement of Comprehensive Income (Profit & Loss Account)


 At the end of the trading year, business produce documents that show key
information relating to the financial performance of the business. One of these
documents is the statement of comprehensive income. This shows the income &
expenses of a business during the financial year.
Example of a Statement of Comprehensive Income:
CHAPTER 34: PROFIT

III. Measuring profitability


1. Gross profit margin
 how much profit business will have to make in order to survive.
 Higher gross margins are usually preferable than lower ones as this shows that
the business is able to cover its costs.
 Gross profit margin may be increased by:
 Raising revenue/ turnover relative to the cost of sales, by increasing
price.

 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 / 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100


 Cutting the cost of sales by finding cheaper suppliers.

2. Operating profit margin


 used to measure a company’s pricing strategy & operating efficiency.
 A high/ increasing operating margin is preferred because more money is made
on each £1 of sales. Operating margin shows the profitability of sales resulting

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 / 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 ×


from regular business.

100

𝑃𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟 (𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡) 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒
3. Profit for the year (net profit) margin

𝑡𝑎𝑥 / 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100

IV. Ways to increase profits/ improve profitability


1. Raising prices
 If demand is inelastic - firms can charge higher price to become more
profitable.
 If demand is elastic - firms will have to charge lower price to become
profitable.
2. Lowering costs
 Buying cheaper resources
 It might be possible to buy raw materials from new suppliers that offer
better prices.
 Another option is to find cheaper labour.
 Using existing resources more efficiently
 Making better use of resources will improve efficiency & lower costs.
Business might do this by introducing new working practices/ training
staff to increase labour productivity.
 Business could also upgrade its machineries so that capital productivity
will increase. Initial costs will be high but gradually it will fall.

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