The Importance of Profit (CIE IGCSE Business)

• Most businesses have the main objective of making a profit
  • Profits help new businesses survive and break-even
  • It is a reward for risks taken by entrepreneurs and investors
  • For more established businesses, profits can enable long-term growth 
    
    
• The most simple formula for calculating profit is:

• Profit can be categorised into net profit and gross profit
  
  
  • Gross profit is the difference between the money received from selling goods or services and the cost of making or providing them
    • It is calculated using the formula
      
      

• • Net profit is the difference between the gross profit and all of the other business expenses
    •  It is calculated using the formula
      
      

• Profit is the surplus that remains after business costs have been subtracted from the total sales revenue
  • If costs exceed revenue, the business makes a loss
    
    

Diagram: The Process of Making a Profit

• Profit can be increased using the following strategies
  • Increasing sales revenues
  • Reducing costs
  • A combination of increasing revenue and reducing costs

• Profit is the financial reward that entrepreneurs receive in return for the risks they take
  • Business owners invest long hours, creativity, their own money, and effort to make a successful business
    
    
• Profit is a useful source of finance
  • E.g. Retained profit can be used to fund the purchase of assets, pay bills and invest in research and development
    
    
• Profit is an indicator of success
  • Increasing profitability suggests that a business is being run effectively and could be an attractive investment
  • Profit levels can be compared over time and with similar businesses to determine how well a business is performing

• Some public sector organisations, such as public corporations, can have the objective of making a profit
  • Although social objectives may be more important, such as serving the local community, profits can be reinvested back into services such as education and healthcare
  • These profits, known as surpluses, could also be used to improve quality and service efficiency 
    
    
• Social enterprises also need to make a profit to survive, as they often have similar objectives to grow so that they can fund their social objectives

• • Profit and cash are different financial terminologies
    • Profit is calculated at a specific point in time
    • While a company may be in profit, they may lack cash as some customers may not actually have paid them yet
      
      
  • Profit is the difference between revenue generated and total business costs during a specific period of time
    
    • Profit can be an important indicator of a company's financial health and long-term success, as it helps to assess the effectiveness of a company's operations
       
  • Cash is measured by taking into account the full range of money flowing in and out of a business
    • This includes revenue from sales, operating expenses, investments, loans, and any other cash-related transactions

Diagram: Profit vs Cash Flow

Profit and Cash-flow are two distinct terms. A business that does not make a profit in the long run will cease to trade

• A profitable business is likely to fail quickly if it does not have sufficient cash
  • Cash-poor businesses will struggle to pay suppliers, employees and operating expenses
  • This is called insolvency 
    • 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