Business Calculations

This section explains Business Calculations. Including information on Gross Profit and Net Profit: including how to calculate them.

Gross Profit

Definition: Gross profit is the amount of money a business earns after subtracting the cost of sales (direct costs) from its revenue.

Formula: Gross Profit = Revenue − Cost of Sales

Example:

Revenue = £50,000

Cost of Sales = £30,000

Gross Profit = £50,000 - £30,000 = £20,000

Net Profit

Definition: Net profit is the money left after all expenses (including indirect costs like rent, wages, and utilities) are deducted from the revenue.

Formula: Net Profit = Gross Profit − Expenses

Example:

Gross Profit = £20,000

Expenses = £10,000

Net Profit = £20,000 - £10,000 = £10,000

3. Gross Profit Margin (GPM)

Definition: Gross profit margin shows the percentage of revenue that remains as gross profit after the cost of sales is deducted. It indicates how efficiently a business produces and sells goods.

Formula:

Gross Profit Margin (%) = (Gross Profit Revenue ÷ Revenue) x 100

Example:

Gross Profit = £20,000

Revenue = £50,000

Gross Profit Margin = (20,000 ÷ 50,000) ×100 = 40%

Using GPM:

Higher Margin: Indicates good control over production costs.

Lower Margin: Suggests the business may need to reduce costs or increase prices.

Net Profit Margin (NPM)

Definition: Net profit margin shows the percentage of revenue that remains as net profit after all expenses are deducted. It measures overall profitability.

Formula:

Net Profit Margin (%) = (Net Profit ÷ Revenue) × 100

Example:

Net Profit = £10,000

Revenue = £50,000

Net Profit Margin = (10,000 ÷ 50,000) × 100 = 20%

Using NPM:

Higher Margin: Indicates the business is managing its overall costs well.

Lower Margin: Suggests expenses may be too high or revenue too low.

Average Rate of Return (ARR)

Definition: The average rate of return measures the profitability of an investment as a percentage of the initial investment cost.

Formula:

ARR (%)=(Average Annual Profit ÷ Initial Investment) × 100

Steps to Calculate ARR:

1. Calculate total profit from the investment over its lifespan.
2. Divide the total profit by the number of years to find the average annual profit.
3. Apply the formula.

Example:

Total Profit = £50,000 over 5 years

Average Annual Profit = 50,000 ÷ 5 = £10,000

Initial Investment = £100,000

ARR = (10,000 ÷ 100,000) × 100= 10%

Using ARR:

Higher ARR indicates a more profitable investment.

Businesses use ARR to compare different investment opportunities.

Summary of Key Formulas

Why These Calculations Matter

• Help businesses assess profitability and efficiency.
• Provide data for informed decision-making.
• Assist in evaluating performance and investment opportunities.