2.3.1 profit, 2.3.2 liquidity, 2.3.3 business failure

types of profit

• profit = total costs - total revenue

• gross profit = sales revenue - cost of sales

• operating profit = gross profit - other expenses

• net profit = operating profit - tax - interest

types of profitability

• gross profit margin = gross profit/sales revenue x 100

  • if gpm is low or failing it means that a firm is not managing its cost of sales effectively or sales are in decline

• operating profit margin = operating profit/sales revenue x 100

  • if opm is low/failing it means that a firm is not managing its expenses effectively

• net profit margin = net profit/sales revenue x 100

  • if low/failing it means gross profit or operating profit are in decline, interest rates and taxation rates have changed

methods of improving profits and profitability

• sell the same quantity at a higher price

• sell more at current

• sell same at same price but reduce costs

liquidity and ways to improve

• a firms ability to meet short term debts and pay day to day expenses

• improve by:

  • reduce the credit period offered to customers (increases current assets)

  • pay suppliers later on agreed credit terms (reduces current liabilities)

  • increase borrowing long terms and clear short term debts (reduces current liabilities)

  • reduce amount of stock held so finished goods can be sold faster and they have money for other things (also helps incase stock spoils or goes out of fashion and is no longer an asset)

current ratio

• current assets/current liabilities

• if higher than 1.0 it suggests that the business has enough cash to be able to pay its debts but not too much finance tied up in current assets which could be reinvested or distributed to shareholders

• if less than 1.0 it suggests that the business is unable to pay its debts and might need to raise extra finance or extend the time to pay creditors

acid test ratio

• current assets - inventory/ current liabilities

• better than current ratio because it gives a clearer picture of a companies ability to pay immediate debts without relying on inventory sales

advantages and disadvantages of ratio analysis

• adv: compare performances over a long period of time, comparable businesses and an industry

• disadv: dont address issues like product quality/ customer service, look at past not future, financial info can be made to look attractive

working capital

• money used to pay day to day expenses

• current assets - current liabilities

internal causes of business failure

• failure to understand the market

  • market research, wrong segment, underestimate degree of competition

• poor planning

  • inaccurate cashflow forecasts, inadequate resources

• poor decision making

  • management inefficiency, lack of innovation

• badly organised

  • poor stock control, inefficient labour, bad customer service, cash flow/ liquidity problems

• overtrading

• non viable idea in the first place

external causes of business

• economic environment

• changing social trends

• demographic changes

• political environment