A-Level Business - Theme 2.3

Types of profit (3)

• Gross Profit

• Operating Profit

• Net Profit

Terms for the costs that vary with level of output (3) D, V, C

• Direct Costs

• Variable Costs

• Cost of goods sold

Terms for costs that DONT vary with level of output (3)

• Indirect Costs

• Overhead

• Expenses

Gross Profit formula

Gross Profit = Total sales revenue - Cost of goods sold

Operating Profit Formula

Operating Profit = Gross Profit - Other Expenses

Net Profit Formula

Net Profit = Operating Profit - Tax & Interest

% Change in profit formula

% Change in profit = (Current year profit - Previous year profit) / Previous year profit X 100

Profitability

The amount of profit relative to revenue or investment, can be measured using profitability ratios, such as profit margins

Profit Margin Formulas

Profit Margin = (Profit (gross/operating/net) / Sales Revenue) X 100

Purpose of Profit Margins (3)

Helps business detect: H, W, H

Helps businesses detect:

• How good it is at turning revenues into profit (profitability)

• Whether there are inefficiencies

• How the PM compare with the industry

How to ↑ profit (4)

• ↓ COGS

• ↓ Expenses

• ↑ Quantity Sold

• ↑ Selling Price

Advantages to ↓ COGS (3) I, H, C

• Increases value added per unit sold

• Higher profit margins on each item

• Customers don't notice a change in price

Disadvantages of ↓ COGS (2) L, C

• Lower input costs = lower quality inputs = greater wastage

• Customers may notice a decrease in quality

Success Factors of ↓ COGS (2) I, F

• If suppliers can be persuaded to offer better prices

• Finding a new supplier

Advantages of ↓ Other Expenses (2) B, D

• ↓ Break Even Output

• A drop in FC directly means higher profits

Disadvantages of ↓ Other Expenses (2) M, I

• May reduce ability of business to increase sales

• Intangible costs (e.g: lower morale after redundancies)

Success Factors of ↓ Other Expenses (2) P, F

• Provided costs don't affect quality/customer service/output

• Whether they can find a cheaper supplier of overheads

Advantages of ↑ Quantity Sold (2) H, M

• Higher sales volume = higher sales (if sp isn't decreased)

• Makes better use of production capacity

Disadvantages of ↑ Quantity sold (3) C, M, F

• Competitors likely to respond

• Marketing efforts may fail

• FC may rise (e.g marketing)

Success Factors of ↑ Quantity Sold (2) I, K

• If business has capacity to sell more

• Keep up with the demands

Advantages of ↑ Selling prices (4) H, M, C, N

• Higher SP = ↑ Sales

• Maximises value extracted from customers

• Customers may perceive the product as higher quality

• No need for extra production capacity

Disadvantages of ↑ Selling price (2) C, C

• Customers likely to respond by going to competition

• Competitors likely to respond

Success Factors of ↑ Selling Prices P, I

• Price Elasticity of Demand

• If customers remain loyal & perceive it to be good value

Statement of Comprehensive Income / Income Statement

The historical record of the trading of a business over a specific period, shows the profit or loss made by a business

Significance of SOCI (4) A, H, E, A

• Allows shareholders/banks to see how the business has performed & see if it has made an acceptable profit

• Helps identify if the profit earned is sustainable (profit quality)

• Enables comparison with other similar businesses

• Allows directors of a company to satisfy legal requirements to report on the financial record of the business

Limitations on Ratio Analysis (5) C, R, R, I, D

• Calculated on past data, may not be a true reflection of business' performance

• Ratios may be based on manipulated data = inaccurate data

• Ratios don't consider qualitative factors

• Identifies there is a problem but not the cause - Difference in accounting methods = hard to compare

Statement of financial position (balance sheet)

Shows what the business has spent money on and where the money invested has come from, a snapshot of the net worth of a business at a fixed point in time

Asset

What the business owns, including cash in the bank

Liabilities

What the business owes

Current Assets

Assets owned for less than a year e.g: stock, cash, trade receivables

Current Liabilities

Short term debts paid back within less that a year e.g: overdraft, trade payables

Net Current Assets / Working Capital Formula

NCA or WC = current assets - current liabilities

Net Assets Formula

Net Assets = Total (NC + C) assets - Total (NC + C) liabilities

Liquidity

The ability to convert an asset into cash to meet liabilities

Liquidity Ratios

Assess whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

Ways to improve liquidity (5) U, E, D, N, D

• Use an overdraft

• Encourage cash sales

• Destocking

• Negotiate longer credit terms with suppliers

• Delay payments

Current Ratio Formula

Current Ratio = Current Assets / Current Liabilities

Acid test ratio formula

Acid Test Formula = (Current Assets - Inventories) / Current Liabilities

Non-Current Assets

An asset owned for more than 1 year, can depreciate (e.g: vehicles, premises, machinery, equipment )

Non-Current Liabilities

A long term debt that will take more than 1 year to repay (e.g: bank loan or mortgage)

Working Capital

The cash needed to pay for the day to day business operations

Depreciation

The decrease in value of an asset overtime

Working Capital Cycle

The length of time between buying raw materials and getting cash from sales of the product

Credit Periods

The number of days that a customer is allowed to wait before paying an invoice

Internal Factors of Business Failure (6) CF, L, M, L, F, P

• Cash flow problems

• Lack of funds (to expand)

• Marketing problems

• Lack of planning

• Failures in technology

• Poor leadership

Business failure - Cash flow problems analysis (3) Need to… -> w/o enough… -> In…

Need to pay short term supplies -> w/o enough cash, won't meet obligations -> insolvencies within business

Business failure - Lack of funds (to expand) analysis (3) Capital… -> w/o it… -> products will…

Capital needed to expand -> w/o it, won't develop production/products -> products will become obsolete

Business failure - Marketing problems analysis (3) Not… -> Little… -> Little…

Not appealing to enough/the right customers -> Little awareness/recognition -> Little sales revenue

Business failure - Lack of planning analysis (4) Moy o/u… -> may waste… -> put into… -> cannot…

May over/underestimate budget -> may waste/run out of money quickly -> put business into debt -> cannot repay liabilities

Business failure - Failures in technology analysis (3) Tech is… -> if it fails… -> may shut…/high…

Tech is vital to run/operate services -> if it fails, can severely create malfunctions/problems -> may shut down/high costs to fix it

Business failure - Poor leadership analysis (3) Communication is… -> w/o it… -> fall…/lack of…

Communication is essential to set targets & collective goals -> w/o it, business lacks efficiency & motivation -> fall behind/lack of progress

External Factors of Business Failure (4) C, C, E, C

• Changes in Legislation

• Competition

• Economic Climate

• Changes in Market Prices

Business failure - Changes in legislation analysis (4) National min… -> increase c… -> decrease pm… -> not enough…

National min wage increase -> increase costs for business -> decrease profit margins -> not enough profit made to keep operating

Business failure - Competition analysis (3) May offer…/have U… -> Attracts… -> eat into…

May offer lower prices/have USP -> Attracts customers and reduce your business' customer base -> eat into market share & reduce sales

Business failure - Economic Climate analysis (3) Increase in…I/U/ Decrease in…W -> Less…c -> less…s

Increase in inflation/ unemployment / decrease in wages -> Less consumer confidence -> less sales on non-essential goods

Business failure - Changes in Market Prices analysis (5) Increase in… -> Increase in… -> Less…s -> Charge… -> Less…d

Increase in prices for raw materials/exports -> increase in production costs -> Less supply made -> Charge higher prices -> less demand/sales