Business 2.3

What is profit

the surplus of revenue over costs

what is the formula

total costs-total revenue

what are the three types

gross

operating

net

formula for gross profit

sales revenue - cost of sales

formula for operating profit

gross profit - expenses

formula for net profit

operating profit - interest

what is a statement of financial position

it summarises the net worth of a business at a given point in time. It balances the net assets with total equity

where is a statement of financial position shown?

What is this thing called

shown on a statement of comprehensive income

this is a formal financial document that summarises a business’ trading activities and expenses to show whether it has made a profit or loss

PLCs and Ltds must do what every year?

publish their accounts, it’s the UK law

what is working capital

how to calculate it

it means the day-to-day finance needed to trade in a business

current assets - current liabilities

explain sales revenue

formula?

money coming in from sales

quantity sold x selling price

explain cost of sales

costs directly linked to the production of the goods or services sold e.g. raw materials

how to calulate gross profit

sales revenue - cost of sales

what are other operating expenses

all other costs associated with the trading of the business e.g. salaries and marketing expenditure

how to calculate operating profit

gross profit - expenses

what is interest and taxation

interest paid on debt or received, plus tax payable of profit

explain exceptional items

any unusually large or infrequent transaction that is not normal

how to calculate profit for the year (net profit)

operating profit - interest and taxation

what is profitability

this measures the financial performance of a business by comparing profits achieved to a second variable e.g. revenue

what is gross profit margin (GPM)

a measure of a firm’s profitability by looking at the relationship between gross profit and sales revenue

if GPM is falling what may it indicate

that a firm is not managing the cost of sales effectively, and sales may be in decline

how is GPM calculated

(gross profit/sales revenue)x100

What is net profit margin (OPM)

a measure of a firm’s profitability by looking at the relationship between net profit and sales revenue

if OPM is falling/low, what may it indicate

the firm is not managing its expenses effectively e.g. wages are increasing

how to calculate OPM

(operating profit/sales revenue)x100

what is net profit margin

a measure of a firm’s profitability by looking at the relationship between profit for the year and sales revenue

if the net profit margin is low or falling, what may it indicate

a firm’s GP or OP are in decline, interest rates have changed, and taxation rates have changed

three ways to improve profits and profitability

sell the same quantity but at a higher price

sell more at the current price

sell the same quantity at the same price but reduce costs

4 factors to consider when selling same amount at a higher price

1. customers being lost

2. competitor prices

3. customer loyalty

4. spending more to maintain brand image

5 factors to consider when selling more at current price

1. customers being gained

2. attracting customers from competitors

3. possible new markets

4. would have to spend more on marketing

5. could encourage existing customers to buy more

3 factors to consider when selling same quantity, at same price, but reduced costs

1. will quality be affected

2. will image be tarnished

3. could you improve operational efficiency

what is the distinction between cash flow and profit

what is cash

how can profitable businesses fail

profit exists in financial records when total revenue is greater than total costs

cash is the physical existence of money within the business

by running out of cash

what is net worth

this is how much would be left after taking all of the business’ assets and turned them into cash and then paid of all the business’ liabilities

what are assets

items of value owned by a business

what are non-current assets

3 examples

likely to be kept by the business for more than one year

1. vehicles

2. premises

3. machinery

what are current assets

3 examples

likely to be kept by the business for less than one year

1. inventories

2. accounts receivable (debtors)

3. cash and cash equivalents

what is a liability in a business

they are debts (money the business owes)

what are non-current liabilities

example

debts that a business has more than a year to pay

1. bank loans

what are current liabilities

example

debts that a business may have to repay within one year

1. overdrafts

2. accounts payable (creditors)

what is liquidity

a measure of a firm’s short term survival i.e. its ability to meet short term debts and day to day expenses

two ways of measuring liquidity

current ratio

acid test ratio

what is current ratio

how to calculate it

current assets:current liabilities

current assets/current liabilities

what is acid test ratio

how to calculate it

liquid assets:current liabilities

(current assets - stocks)/current liabilities

what does a current ratio of 1.5-2.0 suggest

what does a low ratio e.g. below 1 suggest

what does a high ratio e.g. above 2 suggest

efficient management of working capital

cash problems

too much working capital

when evaluating current ratios, look out for?

industry norms

trend is perhaps most important

6 internal causes of business failure

1. failing to understand the market

2. poor planning

3. poor decision making

4. badly organised

5. overtrading

6. non-viable idea in the first place

4 external causes of business failure

1. economic encironment

2. changing social trends

3. demographic changes

4. political environment