2.3 MANAGING FINANCE

PROFIT

• Profits are the surplus of revenue over costs

• There are 3 types of profit:

• These are shown on a statement of comprehensive income

STATEMENT OF COMPREHENSIVE INCOME                                                                                                          Income Statement and 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 - EXPENSES
• Interest and taxation - Interest paid on dept or recieved plus tax payable of profit

• Exceptional items - Any unusually large or infrequent transanction

• Profit for the year (net profit)
  • OPERATING PROFIT - INTEREST AND TAXATION

PROFITABILITY

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

Gross profit margin (GPM)

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

If GPM is low or falling this may indicate that a firm

- is not managing its cost of sales effectively e.g. are the cost of raw materials increasing?

- sales are in decline

Calculated as:

Gross profit / Sales revenue x100

Example:

Sales revenue = £35 000

Cost of sales = £15 750

Gross profit = £19 250 (£35 000 - £15 750)

Gross profit margin = £19 250/£35 000 x 100

= 55%

PROFITABILITY (continued)

Operating profit margin (OPM) is a measure of a firm’s profitability by looking at the relationship between net profit and sales revenue

If OPM is low or falling this may indicate that a firm

- is not managing its expenses effectively e.g. wages are increasing or overheads are going up

- sales are in decline

Calculated as:

Operating profit / sales revenue x 100

Example:

Sales revenue = £35 000

Gross profit = £19 250

Expenses = £ 5 950

Operating profit = £13 300

Operating profit margin = £13 300/£35 000 x 100

= 38%

PROFITABILITY

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

If the profit for the year margin is low or falling this may indicate that a firm

- gross profit or operating profit are in decline

- interest rates have changed

- taxation rates have changed

Calculated as:

Profit for the year / Sales revenue x 100

Example:

Sales revenue = £35 000

Operating profit = £13 300

Interest charges = £ 1 950

Taxation paid = £ 2 600

Profit for the year = £ 8 750 (£13 300 – £1 950 - £2600)

Profit for the year margin = £ 8 750/£35 000 x 100

= 25%

METHODS OF IMPROVING PROFITS AND PROFITABILITY

• Increasing profitability is often a major aim for growing businesses

• There are several ways in which this can be achieved

• Businesses are not limited to one of these options but must realise each option has knock on implications

THE DISTINCTION BETWEEN CASH FLOW AND PROFIT

• Profit exists in financial records when total revenue is greater than total costs

• Cash is the physical existence of money within the business

• Cash flow is the timings of cash flowing in and out of the business

• Profitable businesses can fail because of lack of cash

• Why might cash and profit be different?

STATEMENT OF FINANCIAL POSITION

• Statement of financial position (balance sheet)

STATEMENT OF FINANCIAL POSITION

Assets are items of value owned by a business

Non – current assets

- Likely to be kept by the business for more than one year

- Vehicles

- Premises

- Machinery

Current assets

- Likely to be turned into cash within a year

- Inventories

- Accounts Receivable (Debtors)

- Cash and Cash Equivalents

Liabilities are the money a business owes i.e. debts

Non – current liabilities

- Debts that the business has more than one year to repay

- Bank loans

Current liabilities

- Debts that the business may have to repay within one year

- Overdrafts

- Accounts Payable (Creditors)