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Business · Making financial decisions

Business calculations

Gross profit shows what a business earns from selling its products; net profit shows what is left after every cost. Turning each into a percentage of revenue - the gross and net profit margins - makes performance easy to compare.

  • 8 key terms
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From Topic 1

Answer from memory before the answers appear.

  • How do you calculate revenue?

    Price × quantity sold.

  • How do you calculate total costs?

    Fixed costs + total variable costs.

  • How do you calculate profit?

    Total revenue - total costs.

  • How do you calculate interest as a percentage?

    (Total repayment - borrowed amount) ÷ borrowed amount × 100.

Learning Objectives

  1. 1Calculate gross profit.
  2. 2Calculate net profit.
  3. 3Calculate the gross profit margin.
  4. 4Calculate the net profit margin.
  5. 5Interpret profit and profit margins to judge performance.

Gross Profit

Gross profit = sales revenue - cost of sales.

  • Sales revenue

    The money received from selling products.

  • Cost of sales

    The direct cost of making or buying the products that were sold - raw materials, stock bought to sell and production wages.

  • What it shows

    How much profit the business makes from its products, before paying for everything else.

  • Example

    Bright Bikes sells £500,000 of bikes. The bikes and parts it sold cost £300,000. Gross profit = £500,000 - £300,000 = £200,000.

Net Profit

Net profit = gross profit - other operating expenses and interest.

  • Other operating expenses

    The costs of running the business that are not part of cost of sales - rent, salaries of office staff, marketing, insurance and utilities.

  • Interest

    The cost of borrowing - interest paid on loans and overdrafts.

  • What it shows

    The true profit left for the owners after every cost has been paid.

  • Example

    Bright Bikes' other operating expenses are £120,000 and it pays £10,000 interest. Net profit = £200,000 - £120,000 - £10,000 = £70,000.

Bright Bikes Ltd: Income Statement

  • Sales revenue

    £: 500,000

  • Cost of sales

    £: (300,000)

  • Gross profit

    £: 200,000

  • Other operating expenses

    £: (120,000)

  • Interest

    £: (10,000)

  • Net profit

    £: 70,000

Gross Profit Margin

Gross profit margin (%) = (gross profit ÷ sales revenue) × 100.

  • What it shows

    How many pence of gross profit the business makes from every £1 of sales.

  • A higher margin

    Means the business buys or makes its products cheaply compared with its selling price.

  • How to improve it

    Raise prices, or find cheaper suppliers and cut the cost of sales.

Bright Bikes' Gross Profit Margin

Divide, then multiply by 100.

Bright Bikes' gross profit is £200,000 and its sales revenue is £500,000. Calculate its gross profit margin.

  1. 1 Write the formula GPM = (gross profit ÷ sales revenue) × 100
  2. 2 Put in the numbers = (£200,000 ÷ £500,000) × 100
  3. 3 Work it out = 0.4 × 100 = 40%

AnswerGross profit margin = 40%

Net Profit Margin

Net profit margin (%) = (net profit ÷ sales revenue) × 100.

  • What it shows

    How many pence of net profit the business keeps from every £1 of sales, after all costs.

  • A higher margin

    Means the business controls its costs well.

  • The gap between margins

    A big gap between gross and net margin means operating expenses and interest are taking a large share - a sign to control overheads.

Bright Bikes' Net Profit Margin

Same method, using net profit.

Bright Bikes' net profit is £70,000 and its sales revenue is £500,000. Calculate its net profit margin.

  1. 1 Write the formula NPM = (net profit ÷ sales revenue) × 100
  2. 2 Put in the numbers = (£70,000 ÷ £500,000) × 100
  3. 3 Work it out = 0.14 × 100 = 14%

AnswerNet profit margin = 14%

Bright Bikes at a Glance

  • £200,000

    Gross profit

  • 40%

    Gross profit margin

  • £70,000

    Net profit

  • 14%

    Net profit margin

Case study

Supermarkets: Pennies in the Pound

The UK's big supermarkets sell billions of pounds of food and household goods every year, but their net profit margins are usually very low - often just a few pence of profit for every pound customers spend. Competition on price is fierce, so they keep prices low and make their profit through enormous sales volumes. A luxury brand, by contrast, may sell far less but keep a much larger share of every pound as profit. Comparing margins, not just profit in pounds, shows how differently businesses make their money.

Few pence Net profit per £1 of sales at a typical UK supermarket
Volume How supermarkets make their profit

Run the Accounts

A sports shop has sales revenue of £250,000, cost of sales of £150,000, other operating expenses of £60,000 and interest of £5,000. Calculate its gross profit, net profit, gross profit margin and net profit margin. Then suggest one way to improve each margin.

1. Calculate gross profit.

2. Calculate net profit.

3. Calculate both margins.

4. Suggest improvements.

A good answer shows: Gross profit £100,000; net profit £35,000; GPM 40%; NPM 14%; a way to cut cost of sales or raise prices, and a way to cut overheads.

Can I...?

  1. 1Explain cost of sales.
  2. 2Calculate gross profit.
  3. 3Explain other operating expenses.
  4. 4Calculate net profit.
  5. 5Calculate gross profit margin.
  6. 6Calculate net profit margin.
  7. 7Read an income statement.
  8. 8Suggest how to improve margins.

Summary & Exam Focus

  • Gross profit = sales revenue - cost of sales.
  • Net profit = gross profit - other operating expenses and interest.
  • Gross profit margin = (gross profit ÷ sales revenue) × 100.
  • Net profit margin = (net profit ÷ sales revenue) × 100.

Exam focus

Calculate the net profit margin for a business with net profit of £45,000 and sales revenue of £300,000. (2 marks) (2 marks)

Write the formula, show the division, give the answer with a % sign. Margins always divide by sales revenue - never by costs.

Key terms

The vocabulary this lesson expects you to use. Each one is linked from the first place it appears above.

Sales revenue
The money received from selling products.
Cost of sales
The direct cost of making or buying the products sold.
Gross profit
Sales revenue minus cost of sales.
Other operating expenses
Costs of running the business not included in cost of sales, such as rent and salaries.
Net profit
Gross profit minus other operating expenses and interest.
Gross profit margin
Gross profit as a percentage of sales revenue.
Net profit margin
Net profit as a percentage of sales revenue.
Income statement
A financial statement showing a business's revenue, costs and profit over a period.

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