Calculating revenue, costs and profit

Profit is measured by deducting all the business costs from the revenues generated within a trading period - say 6 months. 

Profits are imprortant for the following reasons:

• They provide a measure of the success of the organisation.
• Profits are the best source of capital for investment in the growth of the business, for example, to fiance new store openings or to pay for new product development. 
• They act as a magnet to attract further funds from investors enticed by the possibility of high returns on their investment. 

However, it is not important for a new business to fail to make profits in the first months - or even years - of trading. The need to generate profits becomes more important as time passes. A business ultimately needs to make profits to reward its owners for putting money into the enterprise. 

Profit is also important to not-for-profit organisations such as charities to tide them over in times of recession to continue funding long-term programmes; allowing them to achieve their stated objectives. 

Sales revenue = no. goods sold x average selling price.

A firm planning to increase its revenue can either sell more or raise their selling price. Some firms may maintain high profits even though this policy depresses sales. Such companies, perhaps selling fashion or tech, believe that in the long run this approach will lead to higher revenues. 

The other way to boost revenue is to charge a low price in an attempt to sell as many products as possible. In some markets this may lead to high revenues and profits. Firms using this approach are likely to be operating in markets in which the goods are fairly similar and consumers do not exhibit strong preferences for sny brand. 

Traditionally, companies printed price lists that might run for 12 months. These days online purchasing makes dynamic pricing more common; that is, allowing prices to rise and fall depending on demand and supply conditions. Football stadiums use this approach. 

Managers need to be aware of the costs of all aspects of their business for a number of reasons:

• They need to know the cost of production to assess whether it is profitable to supply the market at the current price. 
• They need to know actual costs to allow comparisons with their forecasted figures. This will allow them to make judgements concerning the cost-efficiency of different parts of the business.

Fixed costs are any costs that do not vary directly with the level of output. These costs are linked to time rather than to level of business activity. Fixed costs exist even if a business is not producing any goods or services.

If a manufacturer can double output from within the same factory, the amount of rent will not alter, thus it is a fixed cost. Given that fixed costs are inevitable, it is vital that managers work hard at bringing in customers to keep the fixed costs covered.

Other examples of fixed costs include the uniform business rate (local taxes), management salaries, interest charges and depreciation.

In the long term, fixed costs can alter. The manufacturer referred to earlier may decide to increase output significantly. This may require renting additional factory space and negotiating loans for additional capital equipment. Thus rent will rise as may interest payments. We can see that in the long term fixed costs may alter, but that in the short term they are fixed. 

Costs which vary directly with the level of output. They represnt payments made for the use of imputs such as labour, fuel and raw materials. If the manufacturer doubled their output then those costs would double. 

It is not always the case that variable costs rise in proportion to output. Many small businesses discover that as they expand, variable costs do not rise as quickly as output. A key reason for this is that as the business becomes larger it is able to negotiate better prices with suppliers. Its suppliers are likely to agree to sell at lower unit prices when the business places larger orders. 

When added together, fixed and variable costs give the total costs for a business. This is, of course, a very important element in the calculation of the profits earned by a business. 

The relationship between fixed, variable and total costs is straightforward to calculate but has some important implications for a business. If a business has relatively high fixed costs as a proportion of total costs, then it is likely to seek to maximise its sales to ensure that the fixed costs are spread across as many units of output as possible. In this way, the impact of high fixed costs is lessened. 

Profit occurs when revenues are greater than costs. The key formula is:

• Profit = total revenue - total costs 

The purpose behind setting these objectives is to ensure that every manager in the business understands how they fit together. For a cafe there can be a serious gap between what is head office thinks and knows, and what is known by the operating stores. It can make it easier to delegate authority to the store managers if they are clear about the revenue, cost and profit objectives.