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GCSEBusinessEdexcelRevision Notes2. Building a Business2.4 Making Financial DecisionsBusiness Calculations

Business Calculations (Edexcel GCSE Business)

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Profit Calculations

  • Profit is the reward for the risk that entrepreneurs take in proving a product/service 

  • The two main types of profit are gross profit and net profit
     

  • Gross profit takes into account the expenses directly incurred in the cost of production and is calculated as follows 

Gross profit = Sales revenue - cost of sales

  • Net profit takes into account all of the business expenses and is calculated as follows

 Net profit = Gross profit - (operating expenses + Interest)

Worked Example

An e-scooter manufacturer sells its products to retailers for £180 per unit. Variable costs are 2/5ths 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. (6 marks)

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

Calculate the variable cost per unit

⅖ of £180           =           £72                   (1 mark)

Calculate the gross profit per unit (selling price - variable cost per unit)

£180 - £72          =           £108                 (1 mark)

Calculate the gross profit per month (gross profit per unit x units sold)

£108 x 2,200       =          £237,600   

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 annual fixed costs

Annual space fixed space costs space equals space £ 82 comma 000 space straight x space 12 equals space £ 984 comma 000    (1 mark)

Step 3: Calculate the annual Interest

Annual space interest space equals space £ 240 space straight x space 12 space equals space £ 2 comma 880    (1 mark)

Step 4: Calculate the net profit using the formula

 Net space profit space equals space £ 2 comma 851 comma 200 space minus space left parenthesis £ 984 comma 000 space plus space £ 17 comma 000 space plus £ 2 comma 880 right parenthesis Net space profit space equals space £ 2 comma 851 comma 200 space minus space £ 1 comma 003 comma 880 Net space profit space equals space £ 1 comma 847 comma 320

(1 mark or 6 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.

Profit Margins

  • A profit margin is the amount by which 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

 Gross space profit space margin space equals space fraction numerator Gross space profit over denominator Sales space revenue end fraction cross times space 100 space space space space space space

  • Gross profit margin shows the proportion of revenue left over after the business has paid for its costs of sales

  • A business that adds a lot of value would be expected to have a high gross profit margin

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

      Gross space profit space margin space equals space fraction numerator Gross space profit over denominator Sales space revenue end fraction cross times space 100 space space Gross space profit space margin space equals space fraction numerator £ 105 comma 731 over denominator space £ 124 comma 653 space end fraction Gross space profit space margin space 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

Net profit margin

  • The net profit 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

Net space profit space margin space equals space fraction numerator Profit space for space the space year over denominator Sales space revenue end fraction cross times 100 

  • Net profit margin is the proportion of revenue left over after the business has paid all of its costs

  • A business such as Tesco would have a low net profit margin due to the competitiveness of the grocery market

    • However if sales are high, this could still generate significant total profits

  • A business with high net profit margins may have low total profits if sales are low

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 net profit margin in 2022. (2)

Step 1: Substitute the values into the formula

Net space profit space margin space equals space fraction numerator Profit space for space the space year over denominator Sales space revenue end fraction cross times 100 Net space profit space margin space equals space fraction numerator £ 57 comma 596 over denominator £ 124 comma 653 space end fraction Net space profit space margin space 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 

The Average Rate of Return (ARR)

  • The average rate of return (ARR) measures the profit from a proposed capital project

  • ARR is used when a decision is required about which of two projects should be pursued in order to generate the most profit

    • E.g. A business may calculate the ARR of extending a factory and compare this with the ARR of purchasing new machinery

    • They can then make a judgement about which project they should go ahead with

  • The average rate of return is expressed as a percentage and is calculated using the formula

ARR space equals space fraction numerator average space annual space profit space left parenthesis total space profit space divided by space no. space of space years right parenthesis over denominator iInitial space outlay end fraction space space space space space space space cross times space space space space space space space space space 100 space space space space space space

Worked Example

The table below contains information about a new piece of machinery that a business wants to buy

Average annual profit

£200,000

Cost of the machinery

£475,000

Calculate the average rate of return, You are advised to show your workings. (2)

Step 1: Insert the values into the formula

ARR space equals space fraction numerator average space annual space profit space over denominator initial space outlay end fraction space space space space space space space cross times space space space space space space space space space 100 space ARR space equals space fraction numerator £ 200 comma 000 space over denominator £ 475 comma 000 end fraction space space space space space space ARR space equals space 0.42 (1 mark)

Step 2: Multiply by 100 to get a percentage

ARR = 0.42 x 100

ARR = 42%                                                   (1 mark)

 
The Advantages & Disadvantages of Using the Average Rate of Return (ARR)

Advantages

Disadvantages

  • It considers all of the net cash flows generated by an investment over time

  • It is easy to understand and compare the percentage returns with each other

  • As it depends on an average of cash flows, it ignores the timing of those cash flows 

  • The opportunity cost of the investment is ignored 

Sales Revenue Calculations

  • Sales volume is the number of products sold i.e the physical number of units sold

  • Sales revenue = price x quantity sold i.e the financial value of the units sold

  • The market share that a business enjoys is the proportion of the total sales revnue of a product/service compared to the market as a whole e.g. Tesco has 26% of the UK grocery market

  • Market Share can be calculated as follows

fraction numerator Sales space revenue space of space straight a space business over denominator Total space sales space revenue space in space the space market end fraction space cross times space 100 

  • If a business sells multiple items, the percentage that each item contributes to its overall sales revenue can be calculated using the following formula

fraction numerator Sales space revenue space of space product space straight X over denominator Total space sales space revenue space of space all space products end fraction space space cross times space 100

Worked Example

In 2019 a business sold three products, X, Y and Z. Table 1 shows the sales revenue generated for each of these products.

Table 1

Product

Contribution to Sales Revenue (£'s)

 X

300,000

Y

100,000

Z

600,000

Using the information in Table 1, calculate, to 2 decimal places, the percentage of total sales revenue made by product X in 2019. You are advised to show your workings. (2)

   Step 1: Identify annual sales of product x in 2019

   £300,000 

  Step 2: Substitute figures into the formula

              fraction numerator Sales space revenue space of space product space straight X over denominator Total space sales space revenue space of space all space products end fraction space space cross times space 100 equals fraction numerator space £ 300 comma 000 over denominator £ 1000 comma 000 end fraction space cross times space 100

   Step 3: Present the answer to two decimal places

       30.00 %

   1 mark for knowledge of the formula and 1 mark for correct working
    Full marks for the correct answer

Worked Example

Table 2 contains information about the price of a Toyota Rav 4 car between 2016 and 2018.

Year

Price (£'s)

2016

32,000

2017

29,000

2018

26,500

(a) Using the information in Table 2, calculate, the percentage reduction in the price of a Toyota Rav 4 car between 2016 and 2018. (2)

Step 1: Remember this formula to calculate a percentage change

 Percentage space change space equals space fraction numerator new space value space minus space old space value over denominator old space value end fraction space straight x space 100

Step 2: Substitute figures into the formula

 Percentage space change space equals space fraction numerator 26 comma 500 minus space 32 comma 000 over denominator 32 comma 000 end fraction space straight x space 100 space space space bold space stretchy left parenthesis 1 space mark stretchy right parenthesis Percentage space change space equals space fraction numerator negative space 5 comma 500 over denominator 32 comma 000 end fraction space straight x space 100
 

Step 3: Present the answer to two decimal places

- 17,12 %
The price has fallen by 17.12%     (2 marks for the correct answer)
   

(b) Using the information in Table 2, calculate the average price of a Toyota Rav 4 car over the three year period between 2016 and 2018.  (2)

Step 1: Insert values into an average formula

 Error converting from MathML to accessible text.

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