UNIT 2: PROFIT – DETAILED NOTES
1. Meaning of Profit
• Profit is the money left after all costs have been deducted from revenue.
• It belongs to the owners/shareholders of the business.
• Profit shows how successfully a business is operating.
{Profit = Total Revenue – Total Costs}
2. Types of Profit
(a) Gross Profit
• Profit made after direct costs are deducted from revenue.
• Direct costs are called cost of sales.
Cost of sales includes:
• Raw materials
• Direct labour
• Factory costs directly linked to production
Formula:
[{Gross Profit = Revenue – Cost of Sales}
Importance:
• Shows how efficiently a business produces or buys goods.
• Indicates pricing and purchasing efficiency.
(b) Operating Profit
• Profit made after indirect costs (overheads) are deducted from gross profit.
Operating expenses (overheads) include:
• Administration costs
• Selling and distribution expenses
• Marketing expenses
Formula:
[
\textbf{Operating Profit = Gross Profit – Operating Expenses}
]
Importance:
• Shows profitability from core business activities.
• Excludes finance costs and exceptional items.
(c) Profit for the Year (Net Profit)
• Final profit made by the business for the year.
• Takes into account all costs, including finance costs.
Finance costs include:
• Interest on loans
• Interest on overdrafts
Formula:
Profit for the Year (Net Profit) = Operating Profit – Finance Costs}
• May be shown before tax or after tax.
• Known as the “bottom line” profit.
3. Statement of Comprehensive Income (Profit and Loss
Account)
Definition
• A financial statement showing income and expenses over a financial year.
• Used to calculate:
o Gross profit
o Operating profit
o Net profit
Key Features
• Presented in a standard format.
• Shows:
o Current year figures
o Previous year figures (for comparison)
Purpose
• Helps stakeholders assess:
o Business performance
o Profitability trends
o Cost control
4. Ways to Increase Profit
(a) Adjust Marketing Strategy
• Increase advertising
• Introduce promotions (e.g. loyalty cards)
• Use online selling platforms
• Improve customer targeting (social media)
• Encourage repeat purchases
• Increase sales staff incentives
(b) Find New Markets
• Expand nationally or internationally
• Sell to overseas markets
• Target new customer segments
(c) Diversification
• Introduce new products
• Enter new industries
• Spread risk and increase revenue sources
(d) Mergers and Takeovers
• Merge with or acquire other businesses
• Benefits:
o Economies of scale
o Reduced competition
o Cost savings
(e) Disposal of Non-Profitable Activities
• Sell or close loss-making divisions
• Immediate improvement in overall profit
• Allows focus on profitable operations
5. Measuring Profitability (Profit Margins)
Profitability is better measured using ratios, not just absolute profit figures.
(a) Gross Profit Margin
Shows how much gross profit is made from each unit of revenue.
Formula:
[
\textbf{Gross Profit Margin = \frac{Gross\ Profit}{Revenue} \times 100}
]
Higher margin = better
Can be improved by:
• Increasing prices
• Reducing cost of sales
• Finding cheaper suppliers
(b) Operating Profit Margin
Shows operating profit as a percentage of revenue.
Formula:
[
\textbf{Operating Profit Margin = \frac{Operating\ Profit}{Revenue} \times 100}
]
Importance:
• Measures operating efficiency
• Excludes finance costs and tax
• Useful for assessing core business performance
(c) Profit for the Year (Net Profit) Margin
Shows final profit as a percentage of revenue.
Formula:
[
\textbf{Net Profit Margin = \frac{Net\ Profit\ (before\ tax)}{Revenue} \times 100}
]
Importance:
• Focuses on the bottom line
• Reflects total business efficiency
6. Interpretation of Profit Margins
• Gross margin is always the highest
• Net profit margin is always the lowest
• Higher margins = better performance
• Rising margins over time = improvement
• Used to compare businesses within the same industry only
7. Ways to Improve Profitability
(a) Raising Prices
• Increases revenue per unit
• Risk: demand may fall
• Works best if demand is price-inelastic
(b) Lowering Costs
Buying Cheaper Resources
• New suppliers
• Outsourcing
• Overseas labour
• Risks: quality, reliability, brand image
Using Existing Resources More Efficiently
• Staff training → higher labour productivity
• New machinery → higher capital productivity
• Reducing waste and recycling
• Risks: staff resistance, disruption during change
8. Exam Hints (Very Important)
• Always show formulas in calculations
• Always interpret ratios, not just calculate
• Use phrases like:
o “This shows an improvement in efficiency”
o “Profitability has increased over time”
• Compare margins year-to-year
• Never compare businesses from different industries