Profit (Edexcel A Level Business)

• Profit is the money left over after all costs have been accounted for
• There are several different types of profit

Types of Profit

• The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months
  
  
• Each type of profit is calculated within the Statement of Comprehensive Income
  
  
• The previous year’s figures are also shown for comparison purposes
  
  

An Example of a Statement of Comprehensive Income for Head to Toe Wellbeing Ltd

• A profit margin is the amount by which the sales revenue exceeds the costs
  • Profit margins can be calculated for each type of profit (gross, operating and net profit)
    
    
• Profit margins can be compared to previous years to better understand business performance
  • Higher and increasing profit margins are preferable as it means that more revenue is being converted to profit

Gross Profit Margin 

• This shows the proportion of revenue that is turned into gross profit and is expressed as a percentage
  • It is calculated using the formula

 
Operating Profit Margin

• The Operating Profit Margin shows the proportion of revenue that is turned into operating profit and is expressed as a percentage
• It is calculated using the formula

Net Profit Margin

• The net profit margin (also know as the profit for the year margin) shows the proportion of revenue that is turned into net profit before tax and is expressed as a percentage
• It is calculated using the formula

• There are several steps a business can take to improve profitability
   

Ways to improve profitability

Raising prices

• If costs remain the same this will improve profitability as the difference between the selling price and costs is now greater
  • Raising prices is likely to have an impact on demand so businesses must understand the price elasticity of demand for its products
    • Where demand for products is price elastic, increasing prices will result in lower revenue - in this case profitability will be reduced
    • Where demand for products is price inelastic, increasing prices will increase revenue - in this case profitability will rise
      
      

Reducing variable costs 

• This may involve purchasing cheaper/alternative resources, negotiating with suppliers or purchasing in bulk
  • Businesses must ensure that reducing variable costs will not have an adverse effect on the quality or desirability of products
  • Buying stock in greater quantities may require investment in increased storage space which will reduce the impact of the cost savings made
  • Businesses may also be able to reduce wastage of raw materials and components 
     

Reducing other expenses 

• Reducing staffing levels, relocating to cheaper premises or changing utility companies can reduce expenses
  • Reducing staffing levels may affect staff morale and negatively affect productivity
  • Relocation costs can outweigh some benefits of moving to a cheaper location
  • Replacing inefficient or outdated equipment may require staff training
     
    

Reducing one-off costs and interest charges 

• Delaying the purchase of fixed assets, entering leasing arrangements, or restructuring borrowing can reduce costs 
  • Delaying purchases of new fixed assets (e.g.machinery or vehicles) may negatively impact capacity utilisation as a result of increased breakdowns and maintenance of the old equipment
  • The leasing  of equipment (e.g. photocopiers) can reduce one-off purchase costs but the business never owns these assets which weakens the balance sheet
  • Restructuring borrowing can result in lower monthly payments but requires lenders to agree to new terms, which they may not be willing to do
    

• Profit and cash are different financial terminologies
  • Profit is simply the difference between revenue generated and business costs
  • Cash is measured by taking into account the full range of money flowing in and out of a busines
    
    
• A new business may have to pay cash on purchase for all its supplies until a good business relationship has built up a level of trust with its suppliers
  • A supplier may then give the business trade credit of 30 or 60 days
  • This means that the business can receive their stock now and only pay for it in 30 or 60 days - the cash outflow is delayed
  • As the business sells its products, they receive money generated from the business revenue and this represents a cash inflow
  • At the end of 60 days they will pay their supplier (cash outflow), but the firm may still have half of its stock available for sale.
     

• A profitable business is likely to fail if it does not have sufficient cash
  • Cash-poor businesses will struggle to pay suppliers
    • E.g. Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash flow difficulties despite making a profit of £2.6 million during the previous year