EDEXCEL GCSE BUSINESS · PAPER 2
Understanding business performance
Making financial decisions · Lesson 2 of 2
Last Lesson
Answer from memory before the answers appear.
1. How do you calculate gross profit?
Sales revenue - cost of sales.
2. How do you calculate net profit?
Gross profit - other operating expenses and interest.
3. How do you calculate gross profit margin?
(Gross profit ÷ sales revenue) × 100.
4. What is Bright Bikes' net profit margin?
14% (£70,000 ÷ £500,000 × 100).
Learning Objectives
1. Calculate and interpret the average rate of return (ARR).
2. Interpret graphs and charts of business data.
3. Explain the use of financial, market and marketing data in decision making.
4. Explain the use and limitations of quantitative and qualitative data.
PART ONE
Average Rate of Return
Is an investment worth it?
What Is the Average Rate of Return?
The average rate of return (ARR) shows the average yearly profit from an investment as a percentage of what it cost.
▸ Investment. Spending money now to earn more later - a new machine, a new shop or a new delivery van.
▸ Formula. ARR (%) = (average annual profit ÷ cost of investment) × 100.
▸ Average annual profit. (Total returns - cost of investment) ÷ number of years.
▸ What it shows. The higher the ARR, the better the investment. It can be compared with other investments, or with the interest rate a bank would pay.
Calculating ARR
Three steps: total profit, average annual profit, then ARR.
|
Bright Bikes buys a £40,000 machine to build bike frames. Over 4 years it expects the machine to bring in total returns of £56,000. Calculate the average rate of return. |
1. Total profit
£56,000 - £40,000 = £16,000
2. Average annual profit
£16,000 ÷ 4 years = £4,000
3. ARR
(£4,000 ÷ £40,000) × 100 = 10%
Answer: ARR = 10%
Using ARR to Make Decisions
ARR helps a business choose between investments.
▸ Compare investments. Choose the one with the highest ARR.
▸ Compare with interest rates. If the ARR is below what the money would earn in the bank, the investment may not be worth the risk.
▸ Set a target. Some businesses only invest if the ARR is above a set level, such as 10%.
▸ Limitations. ARR relies on forecast returns, which may be wrong, and ignores when the money comes in and non-financial factors.
PART TWO
Reading Business Data
Graphs, charts and what they show.
Bright Bikes: Four Years of Performance
|
A chart shows at a glance what a table of numbers hides. Bright Bikes' revenue rose every year - but in Year 3 its net profit fell, even though sales were higher. That is the question a manager needs to ask: what went wrong with costs in Year 3? |
Revenue rose every year, but net profit fell in Year 3. |
The Figures Behind the Chart
|
Year |
Sales revenue |
Net profit |
Net profit margin |
|---|---|---|---|
|
Year 1 |
£380,000 |
£57,000 |
15.0% |
|
Year 2 |
£420,000 |
£63,000 |
15.0% |
|
Year 3 |
£470,000 |
£56,000 |
11.9% |
|
Year 4 |
£500,000 |
£70,000 |
14.0% |
Interpreting the Data
What a manager learns from Bright Bikes' figures.
▸ Trend. Revenue grew every year, by £120,000 over four years - the business is winning more customers.
▸ Year 3. Net profit fell and the margin dropped to 11.9% - costs rose faster than sales.
▸ Recovery. In Year 4 the margin recovered to 14%, suggesting costs were brought back under control.
▸ The next question. Data shows what happened, but not always why - the manager needs to find out what caused the Year 3 costs.
PART THREE
Using Data to Make Decisions
Different data, different uses.
Types of Business Data
|
Financial data Revenue, costs, profit, margins, cash flow and ARR - how well the business is performing financially. |
Market data The size of the market, how fast it is growing, market share and what competitors are doing. |
|
Marketing data Results of promotions, website visits, customer feedback, sales by product and by segment. |
|
Quantitative or Qualitative Data?
|
QUANTITATIVE DATA (NUMBERS) |
QUALITATIVE DATA (OPINIONS) |
|
▸ Revenue, profit, margins, market share. ▸ Easy to compare over time and with competitors. ▸ Easy to present in graphs and charts. ▸ But: shows what happened, not why. ▸ Can be out of date, or based on forecasts that turn out wrong. |
▸ Customer reviews, staff feedback, focus groups. ▸ Explains why customers and staff behave as they do. ▸ Gives ideas for improvement. ▸ But: harder to measure and compare. ▸ Can be biased, and based on a few people's views. |
The Limitations of Financial Information
Financial data is vital, but it never tells the whole story.
▸ It looks backwards. Accounts show what has already happened, not what will happen next.
▸ It ignores non-financial factors. Staff morale, customer satisfaction and reputation do not appear in the accounts.
▸ Forecasts may be wrong. Future figures, such as ARR returns, are estimates.
▸ Context matters. A fall in profit may be due to a one-off cost or a recession, not poor management.
Key Terms
|
Investment Spending money now in the hope of earning more in the future. |
Average rate of return (ARR) Average annual profit from an investment as a percentage of its cost. |
|
Financial data Information about a business's revenue, costs, profit and cash. |
Market data Information about the market, such as its size, growth and market share. |
|
Marketing data Information about the results of a business's marketing, such as sales and customer feedback. |
Quantitative data Data in the form of numbers. |
|
Qualitative data Data about opinions, feelings and reasons. |
|
Your Task: Which Investment?
15 minutes
|
Bright Bikes has £60,000 to invest. Option A: a new shop costing £60,000, with total returns of £90,000 over 5 years. Option B: a website upgrade costing £60,000, with total returns of £84,000 over 3 years. Calculate the ARR of each, recommend one, and give one non-financial factor Bright Bikes should also consider. 1. Calculate ARR for Option A. 2. Calculate ARR for Option B. 3. Recommend one. 4. Give a non-financial factor. |
A good answer shows: Option A ARR 10% (£30,000 ÷ 5 = £6,000; £6,000 ÷ £60,000 × 100). Option B ARR 13.3% (£24,000 ÷ 3 = £8,000; £8,000 ÷ £60,000 × 100). A recommendation using ARR plus a non-financial factor such as staff or customer experience.
Can I...?
☐ Explain what ARR shows.
☐ Calculate average annual profit.
☐ Calculate ARR.
☐ Use ARR to compare investments.
☐ Interpret a graph of business data.
☐ Explain financial, market and marketing data.
☐ Explain the limits of quantitative and qualitative data.
☐ Explain the limits of financial information.
Summary
✓ ARR = (average annual profit ÷ cost of investment) × 100.
✓ Graphs and charts reveal trends that tables hide.
✓ Financial, market and marketing data all inform decisions.
✓ Quantitative data shows what; qualitative data shows why; financial data has limits.
|
EXAM FOCUS Calculate the average rate of return on an investment costing £50,000 that returns £70,000 in total over 5 years. (2 marks) For ARR, subtract the cost first, then divide by the years, then by the cost. For data questions, quote the actual figures from the question in your answer. |