Profit — Edexcel A-Level Business
Test yourself on Profit with PEARSON EDEXCEL A-Level practice questions.
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Profit explained
Three profit lines sit one below the other on the income statement and each answers a different question.
Read the full explanation
Take revenue, subtract the direct cost of the goods sold and you have the trading margin on the products themselves; subtract overheads such as rent, salaries and marketing and you have what the business earns from running its operations; then take off interest on borrowing and corporation tax to reach what is left for the owners. All three are measured in pounds over a stated period, so the size of a figure means little until it is set against revenue or against capital employed. The gap between the lines is where the diagnosis lives: a strong trading margin with a weak operating figure points at overheads, while healthy operations and a thin bottom line point at borrowing.
b) Statement of comprehensive income (profit and loss account): measuring profitability: calculation of gross profit margin, operating profit margin, and profit for the year (net profit) margin; ways to improve profitability
A margin turns a money figure into a percentage of revenue so that a corner shop and a national chain can be compared on the same basis. Divide the relevant profit line by revenue and multiply by one hundred, do that for all three lines, and the percentages show where money leaks away as it travels down the statement. What counts as healthy is industry specific: Tesco lives on an operating percentage of roughly four per cent because it sells enormous volume, while a luxury fashion label would treat that as a crisis. Improvement means raising price, cutting the cost of goods through supplier negotiation or cheaper inputs, trimming overheads, or shifting the sales mix towards higher earning lines, and each of those costs something in volume, quality or capacity.
c) Distinction between profit and cash
Profit is what the accounts record once a sale is made, while cash is what actually sits in the bank on the day a supplier demands payment, and the two separate because of timing. A firm can invoice a large order on sixty days credit, record the earnings at once and still miss the wage run; it can buy machinery and lose the money immediately while only the depreciation charge reaches the income statement. Inventory build up, capital spending, loan repayments and credit given to customers all drive a wedge between the two. That is why a profitable business can be pushed into administration by a shortage of money in the bank, why rapid growth is dangerous, and why a lender reads the cash flow forecast as carefully as the trading figures.
Your focus
- a) Calculation of: gross profit; operating profit; profit for the year (net profit)
- b) Statement of comprehensive income (profit and loss account): measuring profitability: calculation of gross profit margin, operating profit margin, and profit for the year (net profit) margin; ways to improve profitability
- c) Distinction between profit and cash
Profit exam tips
Marking Points
- The correct order of working: revenue minus cost of sales, then minus operating expenses, then minus interest and tax.
- Working set out line by line with units in pounds and each line labelled, since a marker credits method even where an arithmetic slip loses the final figure.
- Interpretation as well as arithmetic: say what the movement in each line means for the named business, such as overheads rising faster than revenue.
- Selection of the right figures from the extract, ignoring distractors such as dividends paid or capital expenditure that never enter these lines.
- The formula applied correctly: the relevant profit line divided by revenue, multiplied by one hundred, given as a percentage to one decimal place.
- Comparison over time or against a competitor, because a single percentage means nothing until it is benchmarked.
- Diagnosis from the pattern: a steady trading percentage with a falling operating percentage isolates overheads rather than pricing or suppliers.
- A named improvement with its trade-off, such as raising price lifting the percentage but losing volume where demand is price elastic.
- A clear contrast: earnings for a period measured when sales are made, against the actual movement of money in and out, with timing as the reason they differ.
- At least one worked reason for the gap, such as credit sales recorded before the money arrives, or a capital purchase draining the bank while only depreciation reduces earnings.
- Application to the case: identify the firm's own drain, whether that is slow paying customers, seasonal stock building or a large asset purchase.
- The evaluative point that running out of money, rather than trading at a loss, is the immediate cause of most insolvencies, supported by the idea of overtrading.
Examiner Tips
- 💡This is usually a two or four mark calculation attached to a table; label every line of working so method marks survive a slip on the addition.
- 💡Follow on questions ask why profit rose while the bank balance fell, so keep the figures you have calculated and reuse them rather than starting again.
- 💡Always state the unit and the period, because a profit figure with no time period attached cannot be judged.
- 💡Calculations here carry two or four marks; give one decimal place and attach the percentage sign, since an unlabelled number can lose the accuracy mark.
- 💡Longer questions ask whether a firm should cut costs or raise price to improve profitability, so have the elasticity of demand argument ready.
- 💡Where the extract gives several years of figures, comment on the direction of travel rather than the most recent year alone.
- 💡This is a favourite four mark explain question and a standard strand of a twenty mark judgement on whether a growing firm should accept a very large order.
- 💡Where the extract shows rising revenue alongside a falling bank balance, name overtrading explicitly and then explain the mechanism behind it.
- 💡Keep one sentence for the counter argument: an overdraft, debt factoring or sale and leaseback can raise money quickly, so the shortage need not be terminal.
Common Mistakes
- Deducting every cost from revenue in one step and calling the answer gross profit, which quietly turns overheads into cost of sales.
- Treating interest and tax as operating expenses, so the operating line is understated and two separate measures collapse into one.
- Forgetting that cost of sales is opening inventory plus purchases minus closing inventory when the extract gives inventory figures.
- Dividing profit by cost or by capital employed rather than by revenue, which produces a mark up or a return on capital instead.
- Confusing profit with profitability, so a rising money figure is reported as an improvement when the percentage has actually fallen.
- Proposing cost cutting with no comment on the effect on quality, customer service or staff motivation.
- Using the two words interchangeably and then arguing that a profitable firm cannot run out of money.
- Calling depreciation an outflow; it reduces recorded earnings but no money leaves the business in that period.
- Counting a bank loan received as revenue, or a dividend paid as an expense, which corrupts both statements at once.