1. What is the difference between contribution and profit?

2. How to analyse profitability
Objectives;
Calculate and interpret the Gross Profit Margin and Operating Profit Margin
Identify methods of improving profitability
Recognise weaknesses in lowering quality and raising price to increase profitability

3. This profit, that profit and the other…
Profit margin …a comparison of profit to sales revenue
Gross Profit (loss)… the revenue (or deficit) left over after the initial cost of the item which has been sold is deducted
Operating Profit (loss)… the profit (loss) left after other expenses (direct and indirect costs) have been deducted from Gross Profit

4. Which of the following businesses is performing the best?
The Queen Victoria, Walford
From P&L account…
Sales
600
Opening Stock 50
+Purchases
380
-Closing Stock 40
=Cost of Sales
390
Gross Profit
210
Expenses
120
Operating Profit 90
From Balance Sheet…
Fixed Assets
470
Current Assets
140
-Current Liabilities
Working Capital
Net Assets
520
Long term Liabilities
300
Capital & Reserves
220
Capital Employed
The Rovers Return, Weatherfield
From P&L account…
Sales
750
Opening Stock
220
+Purchases
460
-Closing Stock
230
=Cost of Sales
450
Gross Profit
300
Expenses
140
Operating Profit
160
From Balance Sheet…
Fixed Assets
400
Current Assets
100
-Current Liabilities
125
Working Capital
-25
Net Assets
375
Long term Liabilities 50
Capital & Reserves
325
Capital Employed

5. Operating Profit Margin
“The amount of profit a business / product generates after paying expenses, as a percentage of turnover…”
Operating Profit x100%
Sales Revenue
e.g. JT Industries made a Operating Profit of £530,000 from Sales of £2.2m;
£530,000 x100%
£2.2m = 24.1%
In this example, 24.1% of the average selling price is clear profit
The higher the profit margin the better
A falling Operating Profit Margin may suggest that the business is wasting money through unnecessary expenditure
This can be improved by reducing costs whilst maintaining sales
On it’s own this
means NOTHING

6. The Queen Victoria, Walford The Rovers Return, Weatherfield
So who has the better Gross Profit Margin?
The Queen Victoria, Walford
From P&L account…
Sales
600
Opening Stock 50
+Purchases
380
-Closing Stock 40
=Cost of Sales
390
Gross Profit
210
Expenses
120
Operating Profit 90
From Balance Sheet…
Fixed Assets
470
Current Assets
140
-Current Liabilities
Working Capital
Net Assets
520
Long term Liabilities
300
Capital & Reserves
220
Capital Employed
The Rovers Return, Weatherfield
From P&L account…
Sales
750
Opening Stock
220
+Purchases
460
-Closing Stock
230
=Cost of Sales
450
Gross Profit
300
Expenses
140
Operating Profit
160
From Balance Sheet…
Fixed Assets
400
Current Assets
100
-Current Liabilities
125
Working Capital
-25
Net Assets
375
Long term Liabilities 50
Capital & Reserves
325
Capital Employed

7. The Queen Victoria, Walford The Rovers Return, Weatherfield
So who has the better Operating Profit Margin?
The Queen Victoria, Walford
From P&L account…
Sales
600
Opening Stock 50
+Purchases
380
-Closing Stock 40
=Cost of Sales
390
Gross Profit
210
Expenses
120
Operating Profit 90
From Balance Sheet…
Fixed Assets
470
Current Assets
140
-Current Liabilities
Working Capital
Net Assets
520
Long term Liabilities
300
Capital & Reserves
220
Capital Employed
The Rovers Return, Weatherfield
From P&L account…
Sales
750
Opening Stock
220
+Purchases
460
-Closing Stock
230
=Cost of Sales
450
Gross Profit
300
Expenses
140
Operating Profit
160
From Balance Sheet…
Fixed Assets
400
Current Assets
100
-Current Liabilities
125
Working Capital
-25
Net Assets
375
Long term Liabilities 50
Capital & Reserves
325
Capital Employed

8. OPM = Operating Profit x100%
Who is doing ‘better’?
GPM= Gross Profit x100% Sales Revenue
OPM = Operating Profit x100%
Sales Revenue
Company
Year
Turnover
Operating profit
Gross profit
BLOGG plc
2010
£47,238,000
£4,642,000
£22,438,000
2011
£57,859,000
£8,256,000
£29,597,000
ABAY plc
£6,283,000
£269,000
£3,438,000
£4,092,000
£-1,165,000
£2,359,000
BLOGG plc;
OPM: 2010= 9.8% 2011=14.3%
GPM: 2010=47.5% 2011=51.2%
ABAY plc;
OPM: 2010=4.3% 2011=-28.5%
GPM: 2010=54.7% 2011=57.7%

9. Why measure? Comparisons can be made between;
Previous & Current Performance
Own & Competitor Performance
Progress can be tracked and monitored;
Allows analysis of adverse changes
Allows objectives to be set linked to performance
Actions can be taken to improve performance

10. Lower costs will again mean bigger profit margins…
Improving Profits (1)…
This is essentially easy; reduce costs and increase revenues - but there is always a trade off here to consider…
Method
Rationale / method
Potential Drawback
Cutting Costs
Lower costs will again mean bigger profit margins…
Cheaper Supplier
Bulk buy to gain economies of scale
Cut staff wages / training
Cheaper goods often equate to lower quality, which will have an impact on image and demand. Customers may expect cost saving to be passed on. Lower trained / motivated staff are less likely to be efficient / producing quality goods
Raising Prices
Higher contribution means that profit levels will be higher on existing sales
Establish a USP
Assumes price will not affect demand – this is rarely the case due to price elasticity of demand

11. Raising Prices – the reality
The following items increase in price by 10%, what will happen to demand?
Cigarettes
A top of the range FORD Mondeo
Petrol
Apples

12. This ‘short-term’ view is common in the UK
Improving Profits (2)…
This is essentially easy; reduce costs and increase revenues - but there is always a trade off here to consider…
Method
Rationale / method
Potential Drawback
Increase Efficiency
Reducing waste, will lower the costs per unit, improving ROCE (long-run) and OPM
New machinery / systems
Training (higher skilled and so less waste)
Research & Development (to develop USPs’ and better methods of production)
Higher Initial costs, which will mean that in the short-term at least investors will either need to invest more (actually reducing ROCE), or receive less of the profits back.
This ‘short-term’ view is common in the UK

13. Rationalise capacity or product ranges
Improving Profits (3)…
This is essentially easy; reduce costs and increase revenues - but there is always a trade off here to consider…
Method
Rationale / method
Potential Drawback
Rationalise capacity or product ranges
Sub-contract out excess capacity to other firms, or sell of assets to reduce costs and increase ROCE
Sale of Assets
Running at full capacity reduces fixed cost per unit
Discontinue unprofitable lines
By selling off capacity the business will actually reduce in size – not grow!
Image and reputation may be adversely affected if lines or services are cut

14. Task
Assessment activities (page 231) – questions 5-15