Profit 2.3.1

Profit - surplus of revenue when costs are covered

Gross profit -  Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.

Operating profit -  Records how much profit has been made in total from the trading activities of the business before any account is taken of how the business is financed.


Statement of comprehensive income - A formal financial document that summarises a business' trading activities and expenses to show whether it has made a profit or loss.

Profit margin - tells the business just what percentage of its turnover is actually profit. It is the ratio of profit to sales revenue as a percentage

PROFIT = TOTAL REVENUE - TOTAL COSTS

There are 3 types of profit;
  1. Gross Profit
  2. Operating Profit
  3. Profit for the Year
These are shown in a STATEMENT OF COMPREHENSIVE INCOME


Income statement
Explanation
Sales revenue
Money coming in from sales
Quantity sold x selling price
Cost of sales
Costs directly linked to the production of the goods or services sold e.g. raw materials
Gross profit
Sales revenue – cost of sales
Other operating expenses
All other costs associated with the trading of the business e.g. salaries and marketing expenditure
Operating profit
Gross profit – operating expenses
Interest and taxation
Interest paid on debt or received plus tax payable of profit
Exceptional items
Any unusually large or infrequent transaction
Profit for the year (net profit)
Operating profit - interest and taxation





















Sales revenue - costs of sales = GROSS PROFIT - operating expenses = OPERATING PROFIT - interest and taxes and exceptional items = PROFIT FOR THE YEAR (NET PROFIT)

PROFITABILITY

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

There are 3 profitability ratios in Year 1;
  1. Gross profit margin
  2. Operating profit margin
  3. Profit for the year (net profit) margin
1) GROSS PROFIT MARGIN

GPM is a measure of a firm's profitability by looking at the relationship between gross profit and sales revenue.

GROSS PROFIT / SALES REVENUE x 100

Example:

Sales revenue = £35,000
Costs of Sales = £15,750
Gross Profit =  (£35,000 - £15,750) = £19,250
Gross Profit Margin = £19,250/£35,000 x 100
= 55%
This shows that for every £1 of sales, the business gets 55p profit before other costs of sales are made.

If GPM is low or falling, this may indicate that a firm;
  1. sales revenue is declining and therefor more is being needed to be paid towards costs of sales
  2. it's not managing its costs effectively e.g. are the costs of raw materials increasing which means more of sales revenue is having to go towards costs of sales

2) OPERATING PROFIT MARGIN 

OPM is a measure of a firm's profitability by looking at the relationship between operating profit and sales revenue. 

 OPERATING PROFIT / SALES REVENUE X 100

Sales revenue = £35,000
Gross Profit = £19,250
Expenses = £5,950
Operating Profit = £19,250 - £5,950 = £13,300
Operating Profit Margin = £13,300 / £35,000 x 100
= 38%

This shows that for ever £1 of sales, the business earns a profit of 38p

If OPM is low or failing this may indicate that a firm;
  1. Is not managing its expenses effectively e.g. wages are increasing or overheads are going up
  2. Sales are in decline
3) PROFIT FOR THE YEAR MARGIN/ NET INCOME MARGIN

Profit for the year margin is a measure of a firm's profitability by looking at the relationship between profit for the year and sales revenue.

PROFIT FOR THE YEAR (net income) / SALES REVENUE X 100

Sales revenue = £35,000
Operating Profit = £13,300
Interest charges = £1,950
Taxation paid = £2,600
Profit for the year = £13,300 - £1,950 - £2,600 = £8,750 
Profit for the year margin = £8,750 / £35,000 x 100
= 25%

This shows that the business was only able to convert 25% of its sales into profits, while the other 75% was being used to cover interests and taxes.

If the Profit for the year margin is low or falling, this may indicate that a firm is;
  1. Gross profit or Operating profit in decline
  2. Interest rates have changed
  3. Taxation rates have changed 

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