A LevelBusinessEdexcelRevision Notes2. Managing Business Activities2.3 Managing FinanceProfit

Profit (Edexcel A Level Business): Revision Note

Exam code: 9BS0

Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

Updated on

Profit calculations

  • Profit is the money left over after all costs have been accounted for

  • There are several different types of profit

Types of profit

Type of profit

What does it show?

How is it calculated?

Gross profit

(GP)

  • The difference between revenue and the costs directly related to production

GP = revenue − cost of sales

Operating profit

(OP)

  • The difference between the gross profit and the indirect expenses involved in operating the business

OP = gross profit − operating expenses

Net profit

(NP)

  • The difference between the operating profit and any interest paid and received, as well as any one-off costs

NP = operating profit − (net interest + exceptional costs)

Worked Example

An e-scooter manufacturer sells its products to retailers for £180 per unit. Variable costs are ⅖ of the selling price, with monthly fixed costs being £82,000. It sells 2,200 scooters a month. 

The business pays £240 interest on a mortgage each month. This year, it purchased the patent for a new type of rechargeable battery for £17,000.

Calculate the business's net profit for the year.

[5] 

Step 1: Calculate the variable cost per unit


equals space ⅖ space of space £ 180 equals space £ 72 

Step 2: Calculate the gross profit per unit (selling price − variable cost per unit)


equals space £ 180 space minus £ 72 equals space £ 108 space  [1]

Step 3: Calculate the gross profit per month (gross profit per unit × units sold)


equals space £ 108 space cross times space 2 comma 200 equals space £ 237 comma 600 space space space 

Step 4: Calculate the gross profit per year (gross profit per month × 12)


equals space £ 237 comma 600 space cross times space 12 equals space £ 2 comma 851 comma 200  [1]

Step 5: Multiply monthly fixed costs by 12 (months)


equals space £ 82 comma 000 space cross times space 12 space months equals space £ 984 comma 000

Step 6: Subtract the annual fixed costs from the annual gross profit


equals £ 2 comma 851 comma 200 space minus space £ 984 comma 000 equals space £ 1 comma 867 comma 200        [1]

Step 7: Multiply the monthly interest by 12 (months)


equals space £ 240 space space cross times space space 12 equals space £ 2 comma 880 space [1]

Step 8: Add the one-off purchase to the annual interest


equals space £ 17 comma 000 space plus space £ 2 comma 880 equals space £ 19 comma 880

Step 9: Subtract the interest and one-off costs from the operating profit


equals space £ 1 comma 867 comma 200 space minus space £ 19 comma 880 space equals space £ 1 comma 847 comma 320 [1]

Examiner Tips and Tricks

You may not be asked to complete all of these calculations in one question.

The question may, for example, provide the gross profit and some other information and then ask you to calculate the net profit.

Look at the data carefully to ensure you are doing the correct calculation.

Statement of comprehensive income (profit and loss account)

  • The statement of comprehensive income is an end-of-year financial statement that shows all of a business's income and expenses over the previous 12 months

  • Each type of profit is calculated within the statement of comprehensive income

  • The previous year’s figures are also shown for comparison purposes

Example statement of comprehensive income for Head to Toe Wellbeing Ltd

A statement of comprehensive income, comparing 2022 and 2021, showing revenue, costs and profit figures, which include gross profit, operating profit, and profit explanations.
The statement of comprehensive income shows revenue, gross profit, operating profit and profit for the year

Profit margins

  • A profit margin is the amount by which the sales revenue exceeds the costs

    • Profit margins can be calculated for each type of profit (gross, operating and net profit)

  • Profit margins can be compared to previous years to better understand business performance

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

Gross profit margin 

  • This shows the proportion of revenue that is turned into gross profit and is expressed as a percentage

    • It is calculated using the formula

 fraction numerator Gross space profit over denominator Revenue end fraction cross times space 100 space space space space space space

Worked Example

Head to Toe Wellbeing Ltd's revenue in 2022 was £124,653. Its gross profit was £105,731.

Calculate Head to Toe Wellbeing’s gross profit margin in 2022.

[2]

Step 1: Substitute the values into the formula

GPM space equals space fraction numerator Gross space profit over denominator Revenue end fraction space cross times space 100 equals space fraction numerator £ 105 comma 731 over denominator £ 124 comma 653 end fraction equals space 0.8482   [1]

Step 2: Multiply the outcome by 100 to find the percentage

equals space 0.8482 space cross times space 100 equals space 84.82 percent sign        [1]

Operating profit margin

  • The operating profit margin shows the proportion of revenue that is turned into operating profit and is expressed as a percentage

  • It is calculated using the formula

fraction numerator Operating space profit over denominator Revenue end fraction cross times 100

Worked Example

Head to Toe Wellbeing Ltd’s revenue in 2022 was £124,653. Its operating profit was £65,864.

Calculate Head to Toe Wellbeing’s operating profit margin in 2022.

[2]

Step 1: Substitute the values into the formula

OPM space equals space fraction numerator Operating space profit over denominator Revenue end fraction space cross times space 100 equals space fraction numerator £ 65 comma 864 over denominator £ 124 comma 653 space end fraction equals space 0.5284  [1]
 

Step 2: Multiply the outcome by 100 to find the percentage

 
equals space 0.5284 space cross times space 100 equals space 52.84 percent sign space        [1]

Net profit margin

  • The net profit margin (also known as the profit for the year margin) shows the proportion of revenue that is turned into net profit before tax and is expressed as a percentage

  • It is calculated using the formula

fraction numerator Profit space for space the space year over denominator Revenue end fraction cross times 100

Worked Example

Head to Toe Wellbeing Ltd’s revenue in 2022 was £124,653. Its profit for the year was £57,596.

Calculate Head to Toe Wellbeing’s profit for the year margin (net profit) in 2022.

[2]

Step 1: Substitute the values into the formula

NPM space equals space fraction numerator Profit space for space the space year over denominator Revenue end fraction space cross times space 100 equals space fraction numerator £ 57 comma 596 over denominator £ 124 comma 653 end fraction equals space 0.4621        [1]

Step 2: Multiply the outcome by 100 to find the percentage

equals space 0.4621 space cross times space 100 equals space 46.21 percent sign       [1]

Ways to improve profitability

  • There are several steps a business can take to improve profitability

Main ways to improve profitability

Spider diagram on improving profitability with strategies such as increasing prices, reducing variable costs and expenses, and cutting one-off costs.
Businesses can improve profitability by reducing costs or increasing revenue

Raising prices

  • If costs remain the same, raising prices will improve profitability, as the difference between the selling price and the cost is now greater

    • Raising prices is likely to have an impact on demand, so a business must understand the price elasticity of demand for its products

      • Where demand for products is price elastic, increasing prices will result in lower revenue — in this case, profitability will be reduced

      • Where demand for products is price inelastic, increasing prices will increase revenue — in this case, profitability will rise

Reducing variable costs 

  • This may involve purchasing cheaper/alternative resources, negotiating with suppliers or purchasing in bulk

    • Businesses must ensure that reducing variable costs will not have an adverse effect on the quality or desirability of products

    • Buying stock in greater quantities may require investment in increased storage space, which will reduce the impact of the cost savings made

    • Businesses may also be able to reduce the waste of raw materials and components 

Reducing other expenses 

  • Reducing staffing levels, relocating to cheaper premises or changing utility companies can reduce expenses

    • Reducing staffing levels may affect staff morale and negatively affect productivity

    • Relocation costs can outweigh some of the benefits of moving to a cheaper location

    • Replacing inefficient or outdated equipment may require staff training

Reducing one-off costs and interest charges 

  • Delaying the purchase of fixed assets, entering leasing arrangements or restructuring borrowing can reduce costs 

    • Delaying purchases of new fixed assets (e.g. machinery or vehicles) may negatively impact capacity utilisation as a result of increased breakdowns and maintenance of the old equipment

    • The leasing of equipment (e.g. photocopiers) can reduce one-off purchase costs, but the business never owns these assets, which weakens the balance sheet

    • Restructuring borrowing can result in lower monthly payments but requires lenders to agree to new terms, which they may not be willing to do

The distinction between profit and cash

  • Profit and cash are different financial terminologies

    • Profit is simply the difference between revenue generated and business costs

    • Cash is measured by taking into account the full range of money flowing in and out of a business

  • A new business may have to pay cash on purchase for all its supplies until a good business relationship has built up a level of trust with its suppliers

    • A supplier may then give the business trade credit of 30 or 60 days

    • This means that the business can receive its stock now and only pay for it in 30 or 60 days, so the cash outflow is delayed

    • As the business sells its products, it receives money generated from the business revenue, and this represents a cash inflow

    • At the end of 60 days, the business will pay its supplier (cash outflow), but the firm may still have stock available for sale 

  • A profitable business is likely to fail if it does not have sufficient cash

    • Cash-poor businesses will struggle to pay their suppliers

      • E.g. lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash flow difficulties despite making a profit of £2.6 million during the previous year

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    Author
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    Lisa Eades

    Author: Lisa Eades

    Expertise: Business Content Creator

    Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

    Steve Vorster

    Reviewer: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.