1. Business Calculations

What is profit?

The reward for the risk that entrepreneurs take in providing a product/service

What are the two main types of profit?

• Gross profit

• Net profit

What is gross profit?

The revenue a business earns from sales minus the cost of producing or purchasing the goods sold

• DOESN’T include expenses like rent, salaries, or marketing costs—only direct costs related to production

What is net profit?

The amount of money a business has left after deducting all expenses from its total revenue

• Includes costs like rent, salaries, taxes, and marketing

• Net profit shows how much a business actually earns after covering all costs

What is the formula for gross profit?

Sales Revenue - Cost of Sales

What is the formula for net profit?

Gross profit - (operating expenses + interest)

What is a profit margin?

The amount by which sales revenue exceeds the costs

• They can be compared throughout the years to better understand business performance

Higher profit margins are preferable, as it means that more revenue is being converted to profit

What is the gross profit margin?

The proportion of revenue that’s turned into gross profit and is expressed as a percentage. It 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 (difference between the price paid for the factors of production and the selling price of the good/service) would be expected to have a high gross profit margin

What is the net profit margin?

Shows the proportion of revenue that’s turned into net profit before tax and is expressed as a percentage. The proportion of revenue left over after the business has paid all of the costs.

• e.g. 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

What is the formula for gross profit margin?

(Gross profit ÷ Sales Revenue) x 100

What is the formula for net profit margin?

(Profit for the year ÷ Sales Revenue) x 100

What is the average rate of return (ARR)?

It measures the profit from a proposed capital project. It’s used when a decision is needed to be made 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

What is the formula for the average rate of return (ARR)?

(Average Annual Profit ÷ Initial Investment) x 100

• Average Annual Profit = total profit / no. of years

What are the advantages & disadvantages of using the average rate of return (ARR)?

• Considers all of the net cash flows generated by an investment overtime

• It’s 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 (the loss of other alternatives when one alternative is chosen) of the investment is ignored

What is sales volume?

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

What is market share?

The proportion of total sales revenue of a product or service that a business holds compared to the market as a whole. For example, Tesco has 26% of the UK grocery market

What is the formula for market share?

(Sales Revenue of a Business ÷ Total Sales Revenue in the Market) x 100

What is the formula to calculate the percentage that each item contributes to its overall sales revenue?

(Sales Revenue of product X ÷ Total Sales Revenue of All Products) x 100