The Importance of Profit

An introduction to profit

An introduction to profit

• Most businesses have the main objective of making a profit

  • Profits help new businesses survive and break-even

  • It is a reward for risks taken by entrepreneurs and investors

  • For more established businesses, profits can enable long-term growth 

• The most simple formula for calculating profit is:

$\mathrm{Profit} = \mathrm{Sales} \mathrm{Revenue} – \mathrm{Total} \mathrm{Costs}$

• Profit can be categorised into net profit and gross profit

  • Gross profit is the difference between the money received from selling goods or services and the cost of making or providing them

    • It is calculated using the formula

$\mathrm{Gross} \mathrm{Profit} = \mathrm{Sales} \mathrm{Revenue} – \mathrm{Cost} \mathrm{of} \mathrm{Sales}$

• Net profit is the difference between the gross profit and all of the other business expenses

  •  It is calculated using the formula

$\mathrm{Net} \mathrm{Profit} = \mathrm{Gross} \mathrm{Profit} – \mathrm{Expenses}$

• Profit is the surplus that remains after business costs have been subtracted from the total sales revenue

  • If costs exceed revenue, the business makes a loss

The process of making a profit

• Profit can be increased using the following strategies

  • Increasing sales revenues

  • Reducing costs

  • A combination of increasing revenue and reducing costs

The importance of profit to private sector businesses

The importance of profit to private sector businesses

• Profit is the financial reward that entrepreneurs receive in return for the risks they take

  • Business owners invest long hours, creativity, their own money, and effort to make a successful business

• Profit is a useful source of finance

  • E.g. Retained profit can be used to fund the purchase of assets, pay bills and invest in research and development

• Profit is an indicator of success

  • Increasing profitability suggests that a business is being run effectively and could be an attractive investment

  • Profit levels can be compared over time and with similar businesses to determine how well a business is performing

• Some public sector organisations, such as public corporations, can have the objective of making a profit

  • Although social objectives may be more important, such as serving the local community, profits can be reinvested back into services such as education and healthcare

  • These profits, known as surpluses, could also be used to improve quality and service efficiency 

• Social enterprises also need to make a profit to survive, as they often have similar objectives to grow so that they can fund their social objectives

The difference between profit and cash

The difference between profit and cash

• Profit and cash are different financial terminologies

  • Profit is calculated at a specific point in time

  • While a company may be in profit, they may lack cash, as some customers may not actually have paid them yet

• Profit is the difference between revenue generated and total business costs during a specific period of time

  • Profit can be an important indicator of a company's financial health and long-term success, as it helps to assess the effectiveness of a company's operations

• Cash is measured by taking into account the full range of money flowing in and out of a business

  • This includes revenue from sales, operating expenses, investments, loans, and any other cash-related transactions

Profit vs cash flow

• A profitable business is likely to fail quickly if it does not have sufficient cash

  • Cash-poor businesses will struggle to pay suppliers, employees and operating expenses

  • This is called insolvency 

    • Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash-flow difficulties, despite making a profit of £2.6 million during the previous year