- Created by: Natti Gates
- Created on: 18-04-11 13:29
The performance of organisations are measured in many different ways, and the most appropriate measure(s) will depend on the nature of the organisation, and one of the most common measures of performance is net profit...
Net profit measures the profit left after all the operating costs of the business have been deducted. These costs may include the costs of producting and marketing the products as well as fixed costs. It is the lifeblood of the organisation, because unless the business makes a profit, it cannot finance growth.
In a growing economy with new oppertunities arising all the time a business that cannot grow is condemed to a slow death. For example Woolworths, during 2007, every £1 that went through its tills less than 1p was the companys net profit. A business can't survive on that.
NET PROFIT AND NET PROFIT MARGIN FORMULA
The net profit of a business is an absolute number that is measured in value terms. To work out if it is a good profit or not they need to measure the profit in relation to the total sales. This is the NET PROFIT MARGIN:
Net profit margin = Net profit / Sales X 100
( / = divide)
This will come out as a percentage.
WHAT IS A GOOD NET PROFIT MARGIN??
The typical net profit margin in an industry will vary from one sector too another...
If your market has a lot of market share in it, such as the food retail market then your net profit is bound to be low, however, provided you can sell a high enough volume of items your overall net profit can still be high.
In the case of luxury items such as Ted Baker clothes the profit margin is likely to be alot higher. But it does depend on how many items you sell.
THE RETURN ON CAPITAL
The profitability measures profit in relation to some other variables. We might want to measure the net profit in relation to the amount invested into a preoject...
The return on capital is an important indicator of the success of a project or business. Imagine if a business proposal expects to earn a return of 25% this is very good compared to the return you are likely to get if you invest your money into a bank. And this makes the project attractive because the oppertunity cost is probably low.
We would work out the Return on Capital using this formula:
Return on Capital = Net Profit/ Capital invested X 100
This gives a percentage.
METHODS OF IMPROVING PROFITS
To increase a profit you would need to increase revenues, decrease costs or do a cobination of both...
To increase revenue a business may want to consider its marketing mix. Changes to the product may mean that it becomes more appealing to customers. Better distribution may make it more available. Changes to promotion may make customers more aware of its benefits. But the business needs to be more careful that rising costs don't swallow up the rise in sales revenues. To reduce costs a business should think about ways of making the product more efficiently by working fewer imputs or paying less for the imputs being used.
However, a business must be careful that when it reduces costs, the quality of service is not reduced. Because this could lead to a fall in revenue. Such, if you cut the number of staff in a coffee shop this may cause long queues and this could reduce the number of customers and income.
METHODS OF INCREASING PROFIT MARGINS
- Increase its price - this would boost the profit per sale, but the danger is that the sales overal may fall so much that the overal profits of the business are reduced. The impact of price increase will depend on the price elasticity of demand. It is a way of measuring how sharply demands will change when the price of a product is changed.
- Cut Costs - if this can be done without damaging the quality in any significant way then this clearly makes sense. Better bargaining to get supply prices down, or better ways of producing may lead to high profits per sale.
Internal reasons - these come within the control of the management
Return on capital - the profit as a percentage of the capital a firm invests in a project
Oppertunity costs - the return you could get if you invested the money elsewhere.