aqa bus2-measuringimprovingprofit
Post on 20-Oct-2014
1.331 Views
Preview:
DESCRIPTION
TRANSCRIPT
Measuring and Increasing Profit
What this topic is all about
• What is profit (a recap from Unit 1)• Profit & profitability• Return on capital• Ways to improve profit• The difference between profit and cash
flow
Unit 1 Reminder – What is Profit?
Profit is thereward or return for
taking risks & making investments
Profit as an Objective
• For most businesses, making a profit is a key objective
• Profit is the most important source of cash flow & finance for a business
• Remember that there can be reasons for running a business other than the “profit motive”
Calculating Profit
Total Salesless
Total Costs=
Profit (or Loss)
Example
Sales Costs Profit or Loss?
£100,000 £75,000 £25,000 (profit)
£100,000 £125,000 £25,000 (loss)
Total sales > total costsTotal costs > total salesTotal sales = total costs
= Profit= Loss= Break-even
Two Ways of Measuring Profit
• Profit in absolute terms– The £ value of profits earned– E.g. £50,000 profit made in the year
• Profit in relative terms– The profit earned as a proportion of sales achieved
or investment made– E.g. £50,000 profit from £500,000 of sales is a profit
margin of 10%– E.g. £50,000 profit from an investment of £1
million = a 5% return on investment
Two Key Terms to Remember
Capital The amount invested into a business or project
Net profit margin
The percentage return made on sales; calculated as net profit divided by sales
NetProfit
Margin
Net Profit Margin – What is Net Profit?
Net profit is what is left after all the costs of
a business have been
taken from its sales revenue
Example £’000Sales 150
Wages (50)
Energy costs (25)
Marketing (15)
Other overheads (30)
NET PROFIT 30Net profit margin 20%
Net Profit Margin – the formula
Net profit margin =
Net profit (before tax)
SalesX 100
Note: net profit margin is expressed as a percentage
What does Net Profit Margin tell us?
• How effectively a business turns its sales into profit
• How efficiently a business is run• Whether a business is able to “add value”
during the production process (a high margin business must be doing something right!)
The Importance of Comparison (1)
The net profit margin of a business should be compared with other competitors in the same
market, and over time
Example Company A£’000
Company B£’000
Company C£’000
Sales 150 250 500
Net profit 50 25 125
Net margin 20% 10% 25%
The Importance of Comparison (2)
Example Company A£’000
Company B£’000
Company C£’000
Sales 150 250 500
Net profit 50 25 125
Net margin 20% 10% 25%
Company C makes the highest net margin of these three & also the highest sales. So it makes the largest net profit too
Company A makes a higher net profit than Company B even though its sales are lower – because it has a higher net profit margin
ReturnOn
Capital
What is Capital?
Capital is the amount invested in a
businessReturn on capital is
the percentage return on that
investment
Example £’000Net profit 200
Capital 2,500
Return on Capital 8%
Return on capital– the formula
Return on Capital =
Net profit (before tax)
Capital investedX 100
Note: return on capital is expressed as a percentage
What does Return on Capital tell us?
• A measure of the returns made from investing in the business
• How good is the business at converting money invested into profit?
• Provides a means of comparison with other investment opportunities
• Opportunity cost (remember from Unit 1!) – what an investor could have done by investing elsewhere
Methods of Improving
Profits
The Basics of Increasing Profits
Sales
Variable Costsless
Fixed Costsless
Net Profit=
Increase quantity sold
Increase selling price
Reduce VC per unit
Reduce fixed costs
Increase output
Increase quantity sold
Why? Higher sales volumes = higher sales, assuming that the selling price is not lowered Makes better use of production capacity (i.e. fixed costs should not rise) May result in higher market share
Will it work?
Depends on elasticity of demand Sales value may actually fall if price has to be reduced to achieve higher sales volumes Does business have capacity to sell more?
Why it might not work
Competitors are likely to respond Marketing efforts may fail – e.g. promotional campaign does not generate results Fixed costs might actually rise – e.g. higher marketing
Increase selling price
Why? Higher selling price = higher sales (assuming quantity sold does not fall in response) Maximises value extracted from customers Customers may perceive product as higher quality No need for extra production capacity
Will it work?
Depends on price elasticity of demand Sales value may actually fall price rise is matched by an even bigger fall in quantity sold It will work if customers remain loyal and still perceive product to be good value
Why it might not work
Competitors are likely to respond (e.g. prices lower) Customers may decide to switch to competitors
Reduce variable costs per unit
Why? Increase the value added per unit sold Higher profit margin on each item produced and sold Customers do not notice a change in price
Will it work?
Yes, if suppliers can be persuaded to offer better prices Yes, if quality can be improved through lower wastage Yes, if operations can be organised more efficiently
Why it might not work
Lower input costs might mean lower quality inputs – which can lead to greater wastage Customers may notice a decrease in product quality
Increase output
Why? Provides greater quantity of product to be sold Enables business to maximise share of market demand Spreads fixed costs over a greater number of units
Will it work?
Yes, if the extra output can be sold (e.g. finding a new market, offering a lower price for a more basic product) Yes, if the business has spare capacity
Why it might not work
A dangerous option – what if the demand is not there? Fixed costs might actually rise (e.g. stepped fixed costs) Production quality might be compromised (lowered) in the rush to produce more
Reduce fixed costs
Why? A drop in fixed costs translates directly into higher profits Reduces the break-even output Often substantial savings to be made by cutting unnecessary overheads
Will it work?
Yes, provided costs cut don’t affect quality, customer service or output A business can nearly always find savings in overheads
Why it might not work
Might reduce ability of business to increase sales Intangible costs – e.g. lower morale after making redundancies
Some more complex approaches
• Reduce product range– Business often has too many products = complex
operations & inefficiency– Some products may be very low-margin or even
loss-making
• Outsource non-essential functions– A way of reducing fixed costs– Focus the business on what it is good at– Areas to outsource: e.g. IT, call handling, finance
Difference between profit and cash flow
Two Different Concepts
Sales
Variable Costsless
Fixed Costsless
Net Profit=
What is Profit?
Cash Inflows
Cash outflowsless
Net Cash Flow=
What is Cash Flow?
Where cash flow differs from profit
• Timing differences– Sales to customers made on credit– Payments to suppliers
• The way that fixed assets are accounted for– Payment for fixed asset = cash outflow– Cost of fixed asset = treated as an asset not a cost– Depreciation is charged as cost when the value of
fixed assets is reduced
Some examples
TransactionExample
What happensto Profit?
What happensto Cash Flow?
Customer buys goods for £50,000 on 60 days credit
Sales of £50,000 are recognised immediately
Cash inflow of £50,000 when the customer actually pays
Marketing campaign costing £10,000 ordered from marketing agency
Cost of £10,000 included in marketing costs
Cash outflow of £10,000 when the marketing agency is paid
New factory machinery bought for £150,000
No effect. £150,000 added to the value of fixed assets
Cash outflow of £150,000 paid to supplier of machinery
Depreciation charge of £100,000 to reflect use of factory fixed assets
Depreciation of £100,000 included as a cost
No effect on cash flow
Test Your Understanding
http://www.tutor2u.net/business/quiz/improvingprofit/quiz.html
Measuring and Increasing Profit
top related