EDEXCEL GCSE BUSINESS · PAPER 2
Understanding business performance
Making financial decisions · Lesson 2 of 2
Teacher copy - includes the notes for whoever is teaching from it.
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.
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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
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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
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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
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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. |
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Marketing data Results of promotions, website visits, customer feedback, sales by product and by segment. |
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Quantitative or Qualitative Data?
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QUANTITATIVE DATA (NUMBERS) |
QUALITATIVE DATA (OPINIONS) |
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▸ 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. |
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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. |
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Qualitative data Data about opinions, feelings and reasons. |
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Your Task: Which Investment?
15 minutes
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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.
Note: Option B has the higher ARR, but its returns come from a forecast; a good answer questions how reliable each forecast is.
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.
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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. |
Exam Practice: Understanding Business Performance
Answer all questions. Show your working in calculations. · 25 minutes
▸ Question 1 · 1 mark · Define. Define the term 'average rate of return'.
▸ Question 2 · 2 marks · Calculate. A business buys new equipment costing £50,000. It expects total returns of £70,000 over 5 years. Calculate the average rate of return. You…
▸ Question 3 · 2 marks · Outline. Outline one limitation of using financial information to make business decisions.
▸ Question 4 · 3 marks · Explain. Explain one benefit to a business of using qualitative data alongside financial data.
▸ Question 5 · 9 marks · Justify. Justify which one of these two options Crest Hotels Ltd should choose.
Question 1 · 1 mark · Define
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“Define the term 'average rate of return'.” |
HOW TO ANSWER IT Command word: Define. Worth 1 mark, so plan before writing.
Question 1 · mark scheme
1 mark available. Award a mark for each point made.
▸ Average yearly profit as a % of the cost of investment. 1 mark
▸ Model answer. The average annual profit from an investment, expressed as a percentage of the cost of the investment.
Question 2 · 2 marks · Calculate
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“A business buys new equipment costing £50,000. It expects total returns of £70,000 over 5 years. Calculate the average rate of return. You are advised to show your working.” |
HOW TO ANSWER IT Command word: Calculate. Worth 2 marks, so plan before writing.
Question 2 · mark scheme
2 marks available. Award a mark for each point made.
▸ Correct method: ((total returns - cost) ÷ years) ÷ cost × 100. 1 mark
▸ Correct answer: 8%. 1 mark (award 2 marks for the correct answer with no working)
▸ Model answer. Total profit = £70,000 - £50,000 = £20,000. Average annual profit = £20,000 ÷ 5 = £4,000. ARR = (£4,000 ÷ £50,000) × 100 = 8%
Question 3 · 2 marks · Outline
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“Outline one limitation of using financial information to make business decisions.” |
HOW TO ANSWER IT Command word: Outline. Worth 2 marks, so plan before writing.
Question 3 · mark scheme
2 marks available. Award a mark for each point made.
▸ A limitation identified, e.g. backward-looking / ignores non-financial factors / forecasts may be wrong. 1 mark
▸ Developed. 1 mark
▸ Model answer. It does not include non-financial factors (1), such as staff morale or customer satisfaction, which can also affect whether a decision succeeds (1).
Question 4 · 3 marks · Explain
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“Explain one benefit to a business of using qualitative data alongside financial data.” |
HOW TO ANSWER IT Command word: Explain. Worth 3 marks, so plan before writing.
Question 4 · mark scheme
3 marks available. Award a mark for each point made.
▸ A benefit identified. 1 mark
▸ First linked point of explanation. 1 mark
▸ Second linked point of explanation. 1 mark
▸ Model answer. Qualitative data can explain why the financial figures have changed (1). For example, customer reviews might show that sales fell because of poor service rather than high prices (1). This helps managers make the right decision to fix the real problem (1).
Question 5 · 9 marks · Justify
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“Justify which one of these two options Crest Hotels Ltd should choose.” — Crest Hotels Ltd has £200,000 to invest. Option 1: Build 10 new rooms, with an ARR of 12%. Option 2: Build a spa, with an ARR of 9%. Customer reviews often mention that the hotel… |
HOW TO ANSWER IT Command word: Justify. Worth 9 marks, so plan before writing.
Question 5 · mark scheme
9 marks available. Award a mark for each point made.
▸ AO2 (Application, 3 marks): uses the context - 12% vs 9% ARR, reviews, the new competitor. Level 1-3
▸ AO3a (Analysis, 3 marks): chains of reasoning using both financial and qualitative data. Level 1-3
▸ AO3b (Evaluation, 3 marks): a justified choice with a supported judgement. Level 1-3
▸ Model answer. Option 1 has the higher ARR of 12%, so on financial grounds it is the better investment. Reviews saying the hotel is "often fully booked" suggest there is demand for more rooms, so the forecast returns are likely to be achieved. However, ARR relies on forecasts and ignores competition: the new hotel with a spa could attract guests away. Option 2 has a lower ARR of 9%, but the qualitative data shows guests want a spa, and it would help Crest compete with the new hotel. This could protect bookings for its existing rooms, a benefit not captured in the spa's ARR. On balance Crest should choose Option 1, because it has the higher ARR and strong evidence of demand, while its hotel is already full. However, this depends on how many guests the new competitor attracts; if bookings start to fall, the spa may become the better choice.