A LevelBusinessEdexcelRevision Notes2. Managing Business Activities2.3 Managing FinanceProfit

Profit (Edexcel A Level Business)

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Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

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 businesses net profit for the year. (5 marks)
 

Step 1: Calculate the Gross Profit (Revenue - Cost of Sales)

  1. Calculate the variable cost per unit
    ⅖ of £180           =           £72                   (1 mark)

  2. Calculate the gross profit per unit (selling price - variable cost per unit)
    £180 - £72          =           £108                 (1 mark)

  3. Calculate the gross profit per month (gross profit per unit x units sold)
    £108 x 2,200       =          £237,600   

  4. Calculate the gross profit per year (gross profit per month x 12)
    £237,600 x 12     =           £2,851,200       (1 mark)

     

Step 2: Calculate the Operating Profit (Gross profit - Operating Expenses)

  1. Multiply the monthly fixed costs by 12 (months)
    £82,000 x 12                    =       £984,000

  2. Subtract the annual fixed costs from the annual gross profit
    £2,851,200 - £984,000     =      £1,867,200       (1 mark)

Step 3: Calculate the Net Profit (Operating Profit - Net Interest + Exceptional Costs)

  1. Multiple the monthly interest by 12 (months)
    £240 x 12                        =        £2,880 (1 mark)

  2. Add the one-off purchase to the annual interest
    £17,000 + £2,880            =        £19,880

  3. Subtract the interest and one-off costs from the operating profit
    £1,867,200 - £19,880
     

    Net profit for the year      =        £1,847,320      (5 marks for the correct answer)

     

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 & Loss Account)

  • The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months

  • Each type of profit is calculated within the Statement of Comprehensive Income

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

An Example of a Statement of Comprehensive Income for Head to Toe Wellbeing Ltd

A statement of comprehensive income, comparing 2022 and 2021, showing revenue, costs, profit figures; includes gross profit, operating profit, and profit explanations.

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’s revenue in 2022 was £124,653. Its gross profit was £105,731.

 Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022. (2)
 
Step 1: Substitute the values into the formula

      fraction numerator Gross space Profit space over denominator Revenue end fraction space cross times space 100 space space space equals space fraction numerator £ 105 comma 731 over denominator space £ 124 comma 653 space end fraction equals space space 0.8482 space space            (1 mark)

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

   0.8482 x 100

    = 84.82%                   (1 mark)

84.82% of Head to Toe Wellbeing’s revenue was converted into gross profit during 2022

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

begin mathsize 14px style fraction numerator Operating space Profit over denominator Revenue end fraction cross times 100 end style

Worked Example

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

Calculate Head to Toe Wellbeing Ltd’s Operating Profit Margin in 2022. (2)

Step 1: Substitute the values into the formula


fraction numerator Operating space Profit over denominator Revenue end fraction cross times 100 equals space fraction numerator £ 65 comma 864 over denominator £ 124 comma 653 end fraction equals space 0.5284        (1 mark)
 

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

 
0.5284 x 100

=  52.84%                (1 mark)

In 2022 52.84% of Head to Toe Wellbeing’s revenue was converted into operating profit

Net Profit Margin

  • The net profit margin (also know 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’s revenue in 2022 was £124,653. Its profit for the year was £57,596.

 Calculate Head to Toe Wellbeing Ltd’s Profit for the year Margin (net profit) in 2022. (2)

Step 1: Substitute the values into the formula

fraction numerator Profit space for space the space year over denominator Revenue end fraction cross times 100 equals space fraction numerator £ 57 comma 596 over denominator £ 124 comma 653 space end fraction equals space 0.4621        (1 mark)

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

0.4621 x 100

= 46.21%             (1 mark)

46.21% of Head to Toe Wellbeing’s revenue was converted into profit for the year 

Ways to Improve Profitability

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

Flowchart on improving profitability with strategies like increasing prices, reducing variable costs and expenses, and cutting one-off costs.

Ways to improve profitability

Raising prices

  • If costs remain the same this will improve profitability as the difference between the selling price and costs is now greater

    • Raising prices is likely to have an impact on demand so businesses 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 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 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 & 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 their stock now and only pay for it in 30 or 60 days, so the cash outflow is delayed

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

    • At the end of 60 days, they will pay their 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 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
    Reviewer
    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

    Author: 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.