2.3.1 Profitability

What are the three types of profit?

Gross profit, operating profit, net profit

What is the equation for gross profit?

total revenue - total cost of sales

What is the equation for operating profit?

Gross profit-expenses and overheads

What is the equation for net profit?

Operating profit- interest and exceptional costs

What is the statement of comprehensive income?

The income and expenses of a business during the previous financial year

How is operating profit margin calculated?

Operating profit / revenue x 100

How do we calculate net profit margin?

Net profit/ revenue x 100

What does operating profit tell us?

- How effectively a business turns its sales into profits

- How efficiently a business is run

- Whether a business is able to add value during the production process

What are the possible actions to increase profits?

Sales- Increase quantity sold

- Increase selling price

Variable costs- Reduce variable cost per unit

Fixed costs- Increase output

- Reduce fixed costs

How can increasing quantity sold improve profitability?

- Higher sales volume=higher sales

- better use of production capacity

- results in higher market share

- However competirors may respond and fixed costs may rise

How does increasing the selling price improve profitability?

- Higher selling price = higher sales

- Maximise the value extracted from customers

- Customers may perceive products as higher quality

- However customers may decide to switch to competitors

How does reducing the variable cost per unit increase profitability?

- Increase value added per unit sold

- Higher profit margins

- However lower input costs may lead to lower quality input leading to greater wastage. Customers may not like the drop in quality

How does increasing output improve profitability?

- Provides greater amount of product to be sold

- Enables businesses to maximise share of market demand

- However, it is a dangerous option if demand is not present and fixed costs may equally rise

How does reducing fixed costs improve profitability?

- Reduces the break even output

- Substantial savings arebmade bybcutting costs

- However there is a reduction in stability to increased sales and could lower morale bybmaking redundancies