2.3 Measuring and Increasing Profit Finance Measuring and Increasing Profit Profit This unit follows on from the study of profits in Unit 1- Calculating Costs, Revenues and Profits

2.3 Measuring and Increasing Profit Measuring and Increasing Profit “If you don’t do it with excellence, don’t do it at all! Because if it’s not excellent, it won’t be profitable or fun, and if you’re not in business for fun or profit, what the hell are you doing there?” Robert Townsend “ A little bit added to what you’ve already got gives you a little bit more” P. G. Woodhouse

2.3 Measuring and Increasing Profit Measuring and Increasing Profits In this topic you will learn about:  The calculation and understanding of net profit margins  The calculation and understanding of return on capital  Methods of improving profits/profitability  The distinction between cash and profit Revise Unit 1 Profit?

2.3 Measuring and Increasing Profit The calculation and understanding of net profit margins  A business will normally show profit in 2 forms Gross Profit = sales revenue – cost of sales Net Profit= gross profit - expenses  It is net profit that determines the ability of a firm to survive and potentially grow  Net profit is the amount of money left from sales after all costs have been paid e.g. Sales revenue = £35000 Total costs=£27000 Net profit =£ 8000

2.3 Measuring and Increasing Profit The calculation and understanding of net profit margins  Profit is therefore an amount of money  Profitability however is a better measure of performance  Profitability measures the efficiency of a business in generating profit  One measure of profitability is Net Profit Margin (NPM)  NPM measures profit as a percentage of sales

2.3 Measuring and Increasing Profit The calculation and understanding of net profit margins  Net Profit Margin Net Profit x 100 Sales Revenue Sales revenue = £35000 Net profit =£ 8000 e.g £8000 x 100 = 22.8% £35000 What does this mean? For every £1 made in sales, after all costs have been paid, 22.8p is left in profit. Practice Calculation Sales Revenue = £68000 Total Cost = £57800 Net Profit = NPM= How much profit is made for each £1 of sales?

2.3 Measuring and Increasing Profit The calculation and understanding of return on capital  A second measure of profitability is Return on Capital (ROC)  ROC measures profit in relation to the capital invested in the business  ROC is an indication of how effectively the money invested is being used to generate profit  ROC allows for comparisons between alternative investment opportunities Why have vets experienced a rise in ROC?

2.3 Measuring and Increasing Profit The calculation and understanding of return on capital  Return on capital Net Profit x 100 Capital Invested Capital Invested = £ Net profit =£ 8000 e.g £8000 x 100 = 8% £ What does this mean? For every £1 invested in the business £0.08 was generated in profit in that year Practice Calculation Sales Revenue = £68000 Capital Invested = £ ROC = How much profit is made for each £1000 of investment?

2.3 Measuring and Increasing Profit Methods of improving profit / profitability  Increasing profitability is often a major aim for growing businesses  There are several ways in which this can be achieved Sell the same quantity but at a higher price Sell more at the current price Sell the same at the same price but reduce costs  Businesses are not limited to one of these options but must realise each option has knock on implications

2.3 Measuring and Increasing Profit Methods of improving profit / profitability  Sell the same amount at a higher price HOW?  Will you lose customers?  What price do competitors charge?  How loyal are your customers?  Will you have to spend more on maintaining brand image? Currently sell 1000 units at £45 Sales Revenue = £45000 Total Cost = £35000 Profit = £10000 NPM = 22% Plan to sell 1000 units at £48 Sales Revenue = £ Total Cost = £35000 Profit = £ NPM = %

2.3 Measuring and Increasing Profit Methods of improving profit / profitability  Sell more at the current price HOW?  Will you gain new customers?  Can you attract them from your competitors?  Is there a new market you can enter?  Will you have to spend more on marketing?  Can you encourage existing customers to buy more? Currently sell 1000 units at £45 Sales Revenue = £45000 Total Cost = £35000 Profit = £10000 NPM = 22% Plan to sell 1100 units at £45 Sales Revenue = £ Total Cost = £35000 Profit = £ NPM = % Is it clever marketing?

2.3 Measuring and Increasing Profit Methods of improving profit / profitability  Sell the same at the same price but cut costs HOW?  Will you lose customers?  Will quality be affected?  Will image be tarnished?  Can you improve operational efficiency? Currently sell 1000 units at £45 Sales Revenue = £45000 Total Cost = £35000 Profit = £10000 NPM = 22% Plan to sell 1000 units at £45 Sales Revenue = £ Total Cost = £31000 Profit = £ NPM = % What do you think is easier, increase sales or reduce expenses by 5%?

2.3 Measuring and Increasing Profit The distinction between cash 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  Profitable businesses can fail because of lack of cash (Liquidity problems)  Why might cash and profit be different? Credit Sales Bad debts Heavy stock holdings Investment in fixed assets Seasonality Repayment of loans

2.3 Measuring and Increasing Profit Activity - GladRags Move to cheaper premises Source cheaper supplies Offer 10% discount to loyal customers Increase prices by 5% Make her assistant Pippa redundant Gladys runs a small boutique selling ladies fashion in an exclusive shopping mall in Chester. Rising rent, increased competition on the high street and customers’ concerns about their own financial security have all meant profits are down. Gladys knows she must do something soon if her business is to survive. She has come up with a number of possible actions. She has asked you to review these and report on the strengths and weaknesses of each action before making a final recommendation.