5.3 Revenue, costs and profits

Revenue

Revenue is the amount of money a business earns from it's sales.

The formula to calculate revenue is quantity sold x selling price

Ways to increase revenue

1. Increase the price of the product to make more profit from each sale
2. Reduce the price to increase the sales of the product
3. Do some advertising of the product
4. Sell a wider range of products to make revenue from each one

Example question:

A student called Maya runs a small business selling homemade bracelets. Each bracelet is sold for £10. In one month, the student sold 50 bracelets.

Calculate her total revenue for that month.

Answer

Costs

Total costs can be broken down into fixed costs and variable costs.

Fixed costs = Costs that do not change with the level of output produced

Variable costs = Costs that change with the level of output produced. E.g.,

5. Labour costs - As the business sells more, they may need to increase the amount of staff they employ

6. Raw materials - As the business sells more, they may need more materials to make their products. Total costs = Fixed costs + variable costs

7. Rent - A monthly or yearly payment made at a set price.

A business may want to keep its costs low so it can…

1. Increase profits
2. Reduce prices - if their costs are low, they can have competitive prices that are cheaper than their competition.
3. Save money to expand their business

Ways a business can reduce its costs…

1. Finding cheaper supplies of materials
2. Adding new technology instead of workers. This may be expensive to purchase, but once it is running it can produce products quickly and efficiently

Example question:

Maya decides to expand her business with the help of her family. She buys a small space that she rents to produce her bracelets.

Her costs are shown below:

Rent: £200 a month.

Materials: £50 a month

Calculate her costs for the month.

Answer

Profit

Profit is calculated by doing total revenue - total costs.

• If the total revenue is higher than the total cost, the business has made a profit
• If the total cost is higher than the total revenue, the business has made a loss

Example question:

Using the same example as before, what is Maya's total profit or loss?

Answer

Gross Profit: Total revenue - total costs (this is the same as your regular profit)

Net Profit: Gross profit - the expenses of operating the business

Example:

Gross profit = £10,000

Expenses = £8,000

Net profit = £10,000 - £8,000 = £2,000

Calculation and interpretation of profitability ratios

Gross profit margin

The gross profit margin compares the total revenue a business has earned with the cost of the sales it makes.

Gross profit margin

The net profit margin compares the gross profit of the business with its expenses.

For gross and net profit margin calculations, your answer will always be shown as a percentage (%) and businesses aim to have a HIGH %.

Example questions:

1. A small shop has a total revenue of £10,000 for the month. The gross profit for that month is £6,000. Calculate the gross profit margin for the month.
2. A small shop has a total revenue of £10,000 for the month. The net profit for that month is £2,000. Calculate the net profit margin for the month.

Answers:

Calculation and interpretation of Average rate of return (ARR)

Average Rate of Return (ARR)

🔗 Average rate of return (ARR) – A method that looks at the expected profit of an investment with the cost of the investment, to see if it is worthwhile.

Here are the steps to calculate this:

1. Calculate the total profit from the investment.	This is the total revenue • the total cost. E.g. £570,000 • £300,000 = £270,000
2. Calculate the average profit per year	This is the total profit divided by the number of years of the project. E.g. £270,000 / 3 = £90,000
3. Calculate the ARR	Average annual profit / cost of investment x 100. £90,000/£300,000 x 100 = 30%

Pros and Cons of ARR

• Can easily compare a range of project options.
• Can easily compare the investment potential with the potential of a savings account. E.g. if the business saved £10,000 in the bank with an interest rate of 5%, could it earn more by investing that money into a project?
• Ignores the time value of money (E.G Exchange rate, inflation).