Profit (AQA A-Level Business): Revision Notes
Profit
What is profit?
Profit is the financial reward that business owners and shareholders receive for taking the risk of investing in a business. It represents the money left over once all business costs have been subtracted from the revenue earned.
Understanding profit is essential because it:
- Provides an incentive for entrepreneurs to set up and run businesses
- Allows businesses to measure their financial performance
- Indicates whether a business is financially viable
- Can be reinvested to help the business grow
Profit is what motivates entrepreneurs to take risks in business. Without the potential for profit, there would be little incentive to invest time, money, and effort into creating and running a business venture.
Understanding revenue
Revenue is the money a business receives from selling its goods or services. To calculate revenue, you multiply the number of units sold by the selling price of each unit:
Alternative Terms for Revenue
Revenue is also known by other terms:
- Turnover
- Sales turnover
- Sales revenue
All of these terms mean the same thing and refer to the total income from sales.
Calculating Revenue
If a business sells 1,000 chocolate bars at $2 each, the revenue would be:
Types of costs
To calculate profit accurately, you need to understand the different types of costs a business faces.
Variable costs
Variable costs are expenses that change in direct proportion to the level of output a business produces. When production increases, variable costs rise. When production decreases, variable costs fall.
Common examples of variable costs include:
- Direct labour – wages paid to workers directly involved in making products
- Raw materials – the materials used to manufacture goods
Exam Tip: Defining Variable Costs
When defining variable costs, it's not enough to simply say "they vary with output". You must state that they vary directly with output.
Similarly, direct labour is only a variable cost if the workers are directly involved in the production process. Indirect workers (like cleaners or security guards) would be classified as fixed costs.
Fixed costs
Fixed costs are expenses that remain constant in the short term, regardless of how much a business produces. These costs must be paid even if no production takes place.
Common examples of fixed costs include:
- Rent – payments for business premises
- Rates – business property taxes
- Director salaries – senior management pay
Fixed costs don't change with output levels, but they may change over longer time periods (for example, if rent increases when a lease is renewed). The key distinction is that they remain constant regardless of production levels in the short term.
Total costs
Total costs represent all the expenses a business incurs during a given time period. They are calculated by adding fixed costs and variable costs together:
The profit formula
Once you know a business's revenue and total costs, you can calculate its profit using this simple formula:
This formula is fundamental to understanding business performance. A positive profit means the business is making money, while a negative profit (a loss) means costs exceed revenue.
Worked Example: Calculating Business Profit
Scenario: A business produces 10,000 units and sells them for $5 each. The variable costs are $25,000 and the fixed costs are $10,000.
Step 1: Calculate total revenue
\text{Total revenue} = \text{Units sold} \times \text{Price per unit} \\ \text{Total revenue} = 10,000 \times \$5 = \$50,000 \end{array}$$ **Step 2: Calculate total costs** $$\begin{array}{l} \text{Total costs} = \text{Variable costs} + \text{Fixed costs} \\ \text{Total costs} = \$25,000 + \$10,000 = \$35,000 \end{array}$$ **Step 3: Calculate profit** $$\begin{array}{l} \text{Profit} = \text{Total revenue} - \text{Total costs} \\ \text{Profit} = \$50,000 - \$35,000 = \$15,000 \end{array}$$ The business has made a :success[profit of \$15,000].Key Points to Remember
- Profit is the money left after all costs are deducted from revenue – it's the financial reward for taking business risks.
- Revenue is calculated by multiplying units sold by price per unit – also called turnover or sales revenue.
- Variable costs change directly with output levels – examples include direct labour and raw materials.
- Fixed costs remain constant regardless of output – examples include rent, rates and director salaries.
- The profit formula is: Profit = Total revenue − Total cost – master this formula as it's essential for exam questions.