The Importance of Profit (Cambridge International IGCSE Business)

What profit is

What is profit?

• Profit is the difference between the total revenue and the total costs of a business

• 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 simplest 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

How businesses make a profit

• Profit can be increased using the following strategies:

  • Increasing sales revenues
  • Reducing costs
  • A combination of increasing revenue and reducing costs

Exam Hint Don’t just say profit is a “reward” – in exams, show its wider importance, such as providing finance for growth, measuring success, and attracting investors

Why profit is important

Spec point — "importance of profit to private sector businesses: reward for risk-taking, source of finance, measure of success, attract investors"

Why is profit important?

• 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

  • For example, 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

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

• Profit attracts new investors

  • Increasing profits suggest that a business is being run effectively and could be an attractive investment

Profit in the public and charity sector

• 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 are reinvested back into services such as education and healthcare
  • These profits, known as surpluses, are also 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