Making Financial Decisions Flashcards
What is Gross Profit
-Gross profit is the difference between the money received from selling goods and services and the cost of making or providing them.
-It ignores any fixed costs, or
overheads, so it is useful in showing how much profit each product or service generates.
Gross profit = sales revenue − cost of sales
What is Gross Profit Margin
-The gross profit margin is the percentage of sales revenue that is left once the cost of sales has been paid.
-It tells a business how much gross profit is made for every pound of sales revenue received.
-Where a business is able to provide significant
added value, then the gross profit margin will be higher.
Gross profit margin = (gross profit/ sales revenue) x100
Using Gross Profit Margin
-Comparing gross profit margins over time can be useful for businesses.
-If the gross profit margin decreased despite the fact that the sales revenue tripled and gross profit doubled.
-This indicates that the cost of sales, which includes raw materials, increased faster than the business increased the price it charged its customers.
-The business might respond by increasing the price that it charges its customers or by negotiating lower prices for raw materials with its suppliers.
What is Net Profit
-Net profit is the difference between the amount of money received from selling goods and services and all of the costs incurred in order to make them.
-Net profit is often considered to be the more important
profit figure, as it includes all of the fixed costs and other
overheads that a business has to pay.
-Net profit can be negative, which would indicate that a business has made a loss, since its costs are greater than its sales revenue.
Net profit = gross profit − other operating expenses and interest
What is Net Profit Margin
-The net profit margin is the proportion of sales revenue
that is left once all costs have been paid.
-It tells a business how much net profit is made for every pound of sales revenue received.
Net profit margin = (net profit/ sales revenue) x100
Using Net Profit Margin
Comparing the net profit margin with the gross profit margin - By comparing the net profit margin with the gross profit margin for the same time period, a business can identify how significant its fixed costs, or overheads, are.
-This can then be used to identify whether there is any scope to reduce these fixed costs.
-Comparing net profit margins over time - By comparing net profit margins over time, a business can identify what is happening to its costs.
-For example, a decrease in net profit margin indicates either that sales revenue has fallen faster than costs or that costs have increased faster than sales revenue.
What is Average Rate of Return
-The average rate of return is a way of comparing the profitability of different choices over the expected life of an investment.
-To do this, it compares the average annual profit of an investment with the initial cost of the investment.
-This is necessary in order to compare investments that might last for different periods of time.
ARR = (average annual profit/ cost of investment) x100
Calculating Average Rate of Return
-Add up all the cash flows
-Minus the original cost of the project
-Divide this number by the years of the project
-Divide that figure by the cost
-x100 for a percentage
Using Average Rate of Return
-Anything that can provide information about the potential size of the return from an investment decision can be helpful.
-This is because a business will know the return it could get from leaving the money it is going to invest in the bank, so it can compare this number with the estimate of the return it could get from investing the money instead.
What are Charts and Graphs
-A chart is used to present information in the form of a graph, a diagram or a table.
-There are many different types of chart, including pie charts, bar charts, pictograms and infographics.
-A graph is a specific type of chart that illustrates a relationship between two or more variables.
-These are often plotted on two axes, vertical and horizontal. All graphs are types of chart, but not all charts are graphs.
How to Read From Charts and Graphs
-Identify any trends the graph or chart shows
-Check the scales used on the axes
-Be aware of whether the data show units, percentages
or percentage change
-Read the chart title and any labels used
How Costs and Revenues Help Businesses to Make Decisions
-A business should be aware of what is happening to its
total costs and revenues and how well it is able to control them.
-This makes it easier to forecast what might happen in the future.
How Gross and Net Profits Help Businesses to Make Decisions
Identifying what is happening to costs and revenues enables a business to calculate how this might affect both gross profit and net profit, using historical profit information.
How Profit Margins Help Businesses to Make Decisions
-Profit margins can be calculated and compared either to the business’ previous figures or to competitors’ figures.
-They can help a business to understand what is causing any change in its profit levels.
How Cash Flow Help Businesses to Make Decisions
-Businesses need access to cash in order to survive.
-Accurately forecasting the cash flow in and out of a business is crucial when deciding what a business can and cannot afford to do.
