Profit and how to increase it

...and profit for the year

Profit can be calculated in many different ways. For most business purposes, though, it is enough to know gross profit, operating profit and profit for the year.

The gross profit for a business is a absolute number, for example, £10,000. The number is calculated by deducting direct costs from sales revenue. Is £10,000 a good level of profit or not? To find out, it is helpful to measure the profit in relation to the sales revenue. This is the gross profit margin:

Gross profit margin = (gross profit/ sales revenue) x 100

Having turned the profit figure into a %, a comparison can be made with the profitability achieved by other companies.

When City and media analysists are evaluating companies, the number they focus on is operating profit, and then take that as a % of revenue to calculate the operating profit margin:

Operating profit margin: (operating profit/ sales revenue) x 100.

Having turned the profit into a %, a comparison can be made with the profitability achieved by other companies, or looking at one company over time. 

The calculations of profit margins undertaken above can come under the heading 'ratio analysis'. This is a technique used by accountants to analyse business in comparison with a close rival, or to investigate the perfromance of a business over time. A ratio is simply a comparison of one piece of numerical data with another. In the case of profit margins, these comparions are shown in % terms. 

After all costs have been deducted, including interest charges and tax bills, the resulting figure is the profit for the year (earnings). The profit for the year is important because it leads to a huge boardroom decision: the directors must decide how much of that profit to pay out in dividends to shareholders and how much to leave in the business for the reinvestment.

The typical net profit margin in an industry will vary from one sector to another. The food retail market is very competitive and the profit per sale is likely to be quite low. However, provided you can sell a high volume of items your overall net profits can still be high.

In the case of luxury items such as Superdry or Rolex, the profit margin is likely to be much higher. However, although the profit per sale is relatively high, this does ot automatically mean the profits are high - that depends on how many items you sell. 

To increase profita a business must:

• increase revenue
• decrease costs
• do a combo of the above

To increase revenue a business may want to condsider its marketing mix. Changes to the product may mean that it becomes more appealing to customer. Better distribution may makeit more available. Changes to promotion may make customers more aware of its benefits. However, the busienss needs to be careful that rising costs do not swallow up the rise in sales revenue.

To reduce the costs a business may examine many of the functional areas:

• Could the firm continue with fewer staff?
• Could money be saved by switching suppliers?
• Do the firm's sales really benefit from sponsoring the opera?
• Are there ways of reducing wastage?

Increase the price

Increasing the price would boost the profit per sale, but demand may fall. - PED.

Cut costs 

If cutting costs can be done without damaging the quality in any significant way then this clearly makes sense. Better bargaining to get the supply prices down or better ways of producing may lead to higher profits per sale. The business needs to be careful to ensure that reducing costs does not lead to a deterioration of the service or quantity of the product.