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7.3. Business finance

Syllabus
0264–2027–2028
Topic
7.3
Level
—

Learning objectives

7.3.1Revenue• Revenue = Selling price per unit × number of units sold.7.3.2Gross profit• Gross profit = Revenue - cost of sales.7.3.3Profit• Profit = Total revenue - total costs, or gross profit - expenses.7.3.4Working capital• Working capital = Current assets - current liabilities.7.3.5Profit margin• Profit margin = Profit / Revenue × 100 = %.7.3.6Gross profit margin• Gross profit margin = Gross profit / Revenue × 100 = %.7.3.7Return on capital employed (ROCE)• ROCE = Profit / Capital employed × 100 = %.

Calculate revenue

revenue=selling price per unit×number of units soldrevenue=selling\ price\ per\ unit\times number\ of\ units\ sold

Selling 3,200 units at 15eachproducesrevenueof15 each produces revenue of48,000. Use units sold, not units produced, and keep the price and sales volume in the same period.

Revenue is money earned from sales before costs are deducted. It is not profit and it is not necessarily the same as cash received during the period.

Calculate gross profit

gross profit=revenue−cost of salesgross\ profit=revenue-cost\ of\ sales

Revenue of 90,000andcostofsalesof90,000 and cost of sales of54,000 give gross profit of $36,000. Gross profit shows what remains after the direct cost of the goods sold, before operating expenses.

A change can come from selling price, sales mix, purchase prices, production efficiency or inventory valuation. Compare gross profit margin as well as the absolute amount.

Do not deduct all business expenses here. Rent, administration and other operating expenses are deducted later to reach profit.

Calculate profit

profit=total revenue−total costs=gross profit−expensesprofit=total\ revenue-total\ costs=gross\ profit-expenses

If gross profit is 36,000andoperatingexpensesare36,000 and operating expenses are21,000, profit is $15,000. The equivalent revenue-minus-total-cost route must give the same result when the figures use the same definitions and period.

Profit rewards risk and can finance growth, but its meaning improves when compared with revenue or capital employed. A larger business may earn more profit yet have weaker profitability.

Profit is not cash flow: credit sales, inventory purchases, loan repayments and non-cash expenses can make cash movement different.

Calculate working capital

working capital=current assets−current liabilitiesworking\ capital=current\ assets-current\ liabilities

Current assets of 70,000andcurrentliabilitiesof70,000 and current liabilities of46,000 give working capital of $24,000. This is the short-term resource buffer available within the operating cycle.

Negative working capital may indicate payment pressure. Very high working capital may indicate excess inventory, slow receivables or idle cash, so compare composition, timing and industry practice.

Working capital is a balance-sheet difference, not cash, revenue or profit. Positive working capital does not guarantee immediate liquidity.

Calculate profit margin

profit margin=profitrevenue×100profit\ margin=\frac{profit}{revenue}\times100

Profit of 18,000fromrevenueof18,000 from revenue of120,000 gives a profit margin of 15%. The business retains 15 cents of profit from each dollar of revenue after all relevant costs.

A fall may reflect weaker prices, higher cost of sales or rising expenses. Compare periods and competitors, then identify the specific cause before recommending action.

Use profit, not gross profit, in the numerator. A higher margin can coexist with lower total profit if sales volume falls sharply.

Calculate gross profit margin

gross profit margin=gross profitrevenue×100gross\ profit\ margin=\frac{gross\ profit}{revenue}\times100

Gross profit of 42,000onrevenueof42,000 on revenue of140,000 gives a gross profit margin of 30%. This leaves 30% of revenue to cover operating expenses and profit.

A lower margin may result from discounts, higher input cost, waste or a different sales mix. It focuses on the relationship between sales and cost of sales before other expenses.

Do not confuse gross profit margin with profit margin. A stable gross margin does not prevent final profit from falling when operating expenses rise.

Calculate return on capital employed

ROCE=profitcapital employed×100ROCE=\frac{profit}{capital\ employed}\times100

Profit of 50,000fromcapitalemployedof50,000 from capital employed of400,000 gives ROCE of 12.5%. It measures profit generated for each unit of long-term finance invested.

Compare ROCE over time, with similar businesses and with the cost of finance. A rise may come from higher profit, more efficient asset use or a reduction in capital employed; the cause matters.

ROCE is not profit margin: its denominator is capital employed, not revenue. A high ROCE from ageing or underinvested assets may not be sustainable.