Business Calculations (Edexcel GCSE Business)

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Lisa Eades

Profit Calculations

Profit is the reward for the risk that entrepreneurs take in proving a product/service
The two main types of profit are gross profit and net profit
Gross profit takes into account the expenses directly incurred in the cost of production and is calculated as follows

Gross profit = Sales revenue - cost of sales

Net profit takes into account all of the business expenses and is calculated as follows

Net profit = Gross profit - (operating expenses + Interest)

Worked example

An e-scooter manufacturer sells its products to retailers for £180 per unit. Variable costs are 2/5ths of the selling price, with monthly fixed costs being £82,000. It sells 2,200 scooters a month.

The business pays £240 interest on a mortgage each month. This year it purchased the patent for a new type of rechargeable battery for £17,000.

Calculate the businesses net profit for the year. (6 marks)

Step 1: Calculate the Gross Profit (Revenue - Cost of Sales)

Calculate the variable cost per unit

⅖ of £180 = £72 (1 mark)
Calculate the gross profit per unit (selling price - variable cost per unit)

£180 - £72 = £108 (1 mark)
Calculate the gross profit per month (gross profit per unit x units sold)

£108 x 2,200 = £237,600
Calculate the gross profit per year (gross profit per month x 12)

£237,600 x 12 = £2,851,200 (1 mark)

Step 2: Calculate the annual fixed costs

$Annual fixed costs = £ 82, 000 x 12 = £ 984, 000$ (1 mark)

Step 3: Calculate the annual Interest

$Annual interest = £ 240 x 12 = £ 2, 880$ (1 mark)

Step 3: Calculate the net profit using the formula

$Net profit = £ 2, 851, 200 - (£ 984, 000 + £ 17, 000 + £ 2, 880) Net profit = £ 2, 851, 200 - £ 1, 003, 880 Net profit = £ 1, 847, 320$ (1 mark or 6 for the correct answer)

Exam Tip

You may not be asked to complete all of these calculations in one question. The question may, for example, provide the Gross Profit and some other information and then ask you to calculate the net profit.

Look at the data carefully to ensure you are doing the correct calculation.

Profit Margins

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

$Gross profit margin = \frac{Gross profit}{Sales revenue} \times 100$

Gross profit margin shows the proportion of revenue left over after the business has paid for its costs of sales
A business that adds a lot of value would be expected to have a high gross profit margin

Worked example

Head to Toe Wellbeing’s revenue in 2022 was £124,653. Its gross profit was £105,731. Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022. (2)

Step 1: Substitute the values into the formula

$Gross profit margin = \frac{Gross profit}{Sales revenue} \times 100 Gross profit margin = \frac{£ 105, 731}{£ 124, 653} Gross profit margin = 0.8482$ (1 mark)

Step 2: Multiply the outcome by 100 to find the percentage

0.8482 x 100

= 84.82% (1 mark)

84.82% of Head to Toe Wellbeing’s revenue was converted into gross profit during 2022

Net Profit Margin

The net profit 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

$Net profit margin = \frac{Profit for the year}{Sales revenue} \times 100$

Net profit margin is the proportion of revenue left over after the business has paid all of its costs
A business such as Tesco would have a low net profit margin due to the competitiveness of the grocery market
- However if sales are high, this could still generate significant total profits
A business with high net profit margins may have low total profits if sales are low

Worked example

Head to Toe Wellbeing’s revenue in 2022 was £124,653. Its profit for the year was £57,596. Calculate Head to Toe Wellbeing Ltd’s net profit margin in 2022. (2)

Step 1: Substitute the values into the formula

$Net profit margin = \frac{Profit for the year}{Sales revenue} \times 100 Net profit margin = \frac{£ 57, 596}{£ 124, 653} Net profit margin = 0.4621$ (1 mark)

Step 2 - Multiply the outcome by 100 to find the percentage

0.4621 x 100

= 46.21% (1 mark)

46.21% of Head to Toe Wellbeing’s revenue was converted into profit for the year

The Average Rate of Return (ARR)

The average rate of return (ARR) measures the profit from a proposed capital project
ARR is used when a decision is required about which of two projects should be pursued in order to generate the most profit
- E.g. A business may calculate the ARR of extending a factory and compare this with the ARR of purchasing new machinery
- They can then make a judgement about which project they should go ahead with
The average rate of return is expressed as a percentage and is calculated using the formula

$ARR = \frac{average annual profit (total profit / no . of years)}{iInitial outlay} \times 100$

Worked example

The table below contains information about a new piece of machinery that a business wants to buy

Average annual profit	£200,000
Cost of the machinery	£475,000

Calculate the average rate of return, You are advised to show your workings. (2)

Step 1: Insert the values into the formula

$ARR = \frac{average annual profit}{initial outlay} \times 100 ARR = \frac{£ 200, 000}{£ 475, 000} ARR = 0.42$ (1 mark)

Step 2: Multiply by 100 to get a percentage

ARR = 0.42 x 100

ARR = 42% (1 mark)

The Advantages & Disadvantages of Using the Average Rate of Return (ARR)

Advantages

Disadvantages

It considers all of the net cash flows generated by an investment over time
It is easy to understand and compare the percentage returns with each other

As it depends on an average of cash flows it ignores the timing of those cash flows
The opportunity cost of the investment is ignored

Sales Revenue Calculations

Sales volume is the number of products sold i.e the physical number of units sold
Sales revenue = price x quantity sold i.e the financial value of the units sold
The market share that a business enjoys is the proportion of the total sales revnue of a product/service compared to the market as a whole e.g. Tesco has 26% of the UK grocery market
Market Share can be calculated as follows

$\frac{Sales revenue of a business}{Total sales revenue in the market} \times 100$

If a business sells multiple items, the percentage that each item contributes to its overall sales revenue can be calculated using the following formula

$\frac{Sales revenue of product X}{Total sales revenue of all products} \times 100$

Worked example

In 2019 a business sold three products, X, Y and Z. Table 1 shows the sales revenue generated for each of these products.

Table 1

Product

Contribution to Sales Revenue (£'s)

300,000

100,000

600,000

Using the information in Table 1, calculate, to 2 decimal places, the percentage of total sales revenue made by product X in 2019. You are advised to show your workings. (2)

Step 1: Identify annual sales of product x in 2019

£300,000

Step 2: Substitute figures into the formula

$\frac{Sales revenue of product X}{Total sales revenue of all products} \times 100 = \frac{£ 300, 000}{£ 1000, 000} \times 100$

Step 3: Present the answer to two decimal places

     30.00 %

   1 Mark for knowledge of the formula and 1 marks for correct working
    Full marks for the correct answer

Worked example

Table 2 contains information about the price of a Toyota Rav 4 car between 2016 and 2018.

Year

Price (£'s)

2016

32,000

2017

29,000

2018

26,500

(a) Using the information in Table 2, calculate, the percentage reduction in the price of a Toyota Rav 4 car between 2016 and 2018. (2)

Step 1: Remember this formula to calculate a percentage change

$Percentage change = \frac{new value - old value}{old value} x 100$

Step 2: Substitute figures into the formula

$Percentage change = \frac{26, 500 - 32, 000}{32, 000} x 100 (1 mark) Percentage change = \frac{- 5, 500}{32, 000} x 100$

Step 3: Present the answer to two decimal places

- 17,12 %
The price has fallen by 17.12% (2 marks for the correct answer)

(b) Using the information in Table 2, calculate the average price of a Toyota Rav 4 car over the three year period between 2016 and 2018. (2)

Step 1: Insert values into an average formula

$Average price = \frac{sum of all prices}{number of price points} Average price = \frac{32, 000 + 29, 000 + 26, 500}{3} (1 mark) Average price = \frac{87, 500}{3} Average price = £ 29, 166, 67 (2 marks for the correct answer)$

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Business Calculations (Edexcel GCSE Business)

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Gross Profit Margin

Net Profit Margin

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Author: Lisa Eades