3.5 - Analysing Financial Performance

Question 1

What are the 4 different types of profit? How are they calcualted?

Answer 1

In general profit = total revenue - total costs

GROSS PROFIT
sales - cost of sales

NET PROFIT aka opersating profit (profit from operations-before tax, interest etc)
gross profit - expenses

PROFIT FOR THE YEAR (profit left to reinvest/pay out to shareholders)
net profit - all other costs (interest, tax etc)

Question 2

What are profit margins? How are they calculated?

Answer 2

Profit as a percentage of sales revenue (proportion of sales revenue leftover as profit after costs)

Profit margin = (profit/sales revenue) x 100

Can be calculated for gross or net profit

Question 3

What are the 2 other types of profit margin? How are they calculated?

Answer 3

GROSS PROFIT MARGIN

• (gross profit/sales revenue) x 100
• A measure of a company’s profitability

OPERATING PROFIT MARGIN aka net profit margin

• (operating profit/sales revenue) x 100
• Sales after VC but before interest, tax etc

Question 4

What is the difference between profit and profitability?

Answer 4

Profit is an absolute number

Profitability is a relative measure where comparisons are made and show the extent to which profit has been made

Question 5

What does cost of sales include?

Answer 5

Direct costs - paid to make/provide goods/service

VARIABLE COSTS

Eg/ stock, raw materials

Question 6

What does a higher gross profit margin show?

Answer 6

The more a business has added as a mark up on the cost to produce

To fully analyse have to compare to similar brand/previous figures

Suggests strong brand

Question 7

How can gross prfit be improved?

Answer 7

Need to increase gap between sales revenue and direct costs, so

• increase prices
  (depends on elasticity-will this keep/lose customers)
• decrease costs
  (switch suppliers-service/quality implications)
  (reduce wastage-make it right first time)
  (better bargaining with suppliers-long term/bulking deals)

Question 8

Which figure is revews and assessed by shreaholders?How coudl this margin be improved?

Answer 8

Net/operating profit

TO IMPROVE

• increase selling price
• decrease costs (direct and overheads)

Question 9

How can overhead costs be reduced?

Answer 9

Fewer staff

Remove least effective advertising

Reduce wastage

Outsourcing - get another company to do some of your work for you eg/cleaning

Question 10

How can profit and profitability increase?

Answer 10

PROFIT

• spend more in advertising, expand product range, change prices
• decrease costs

PROFITABILITY
- reducing costs, increasing turnover, increasing productivity, increasing efficiency

Question 11

What are 2 ways to measure profitability?

Answer 11

GROSS profit margin

NET/operating profit margin

Question 12

Explain the drawbacks of improving profits through making staff redundant, reducing employee wages, moving to a cheaper location, changing to a cheaper supplier and increasing prices

Answer 12

Making staff redundant

• demotivation of staff-worry about job security
• could impact service level

Reducing employee wages

• demotivation
• slower work rate, industrial action (strike), higher proportion leave
• service level impacted

Moving to a cheaper location

• initial cost to do it
• could be less footfall due to being less convenient
• transport, environment and ethical issues if moving abroad

Changing to a cheaper supplier
- quality issues-impacts reputation and sales

Increasing prices
- impact depends on elasticity (balance has to be right-still a change if slightly inelastic)

Question 13

What is contribution? How is contribution per unit and total contribution (analytic method) calculated?

Answer 13

Amount of money after VC of production has been paid-if it exceeds FC, business is making profit (firm breaks even when total cpntributio or total revenue=total costs)

1 Contribution PER UNIT
Selling price - variable cost per unit
2 TOTAL contribution
Sales revenue - total variable costs

Question 14

How is break even output calculated?

What is break even output? What are the factors affecting it?

Answer 14

Fixed costs / (selling price -variable cost)

level at which total sales revenue is equal to total costs of production

FACTORS
- changes to selling price
(eg/ higher selling price-increase effect on contribution, lower effect on break even output)

• changes to fixed costs
  (eg/ increase in fixed costs-effect on contribution stays same, effect on break even output increases-needs to sell more)
• changes to variable costs
  (eg/ higher variable costs-decrease effect on contribution, increase effect on break even output)

Question 15

What is break even analysis? What are the 2 strengths and 2 limitations?

Answer 15

Study of relationship between TC and TR to identify level of output at which business breaks even (no profit,no loss)

+ focuses on what output is required before business reaches profitability

+ helps management and finance providers better understand viability and risk of business or idea

• variable costs do not stay the same
• a planning aid rather than a decision making tool

Question 16

How is margin of safety calculated? What is it?

Answer 16

Actual sales - break even level of sales

Amount sales can fall before firms starts making a loss