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ACTIVITY 1: To be able to explain and apply the term profit [LO 3.2]
The nature of profit
Profit can be regarded as the difference between the income and expenditure of a business.
It is the amount by which income exceeds the expenditure incurred to produce the income.
The main objective of anyone who starts a business is to make maximum profit. This profit can be regarded as the owner’s compensation for the use of his capital. The profit he makes must be considerably more than the interest he would have earned if he had invested the money in the bank.
It is important for the business to be managed in such a way as to ensure a good return on the owner’s capital investment in his business.
Calculating profit
In order to calculate the profit, certain information about the business is required. This is obtained from a statement that is usually drawn up at the end of the financial year. The statement contains the income generated during a particular period, as well as the expenditure incurred in order to generate that income. This statement is called an Income Statement.
When calculating profit, businesses can be divided into two main groups according to the nature of their activities, namely:
service enterprises and
commercial enterprises
Service enterprises provide a service and earn an income by doing so, for example hairdressers, dry-cleaning businesses, medical practitioners, dentists, etc.
Commercial enterprises purchase merchandise and sell it at a higher price than the purchase price to make a profit.
The profit of these businesses can be calculated by doing a simple deduction, namely:
Profit = Income – Expenditure
Effective leadership and management strategies are used to minimise expenditure and maximise income of a business.
One strategy is to exercise strict control over expenditure such as telephone, water, electricity, transport costs, stationery and advertising. These expenses must be compared monthly. If there is a significant increase the cause must be found and rectified.
At the same time the income must be kept as high as possible.
In a service enterprise, excellent service must be provided at all times, because satisfied clients are the best advertisement for any business.
In the case of commercial enterprises, the lowest possible purchase price and the highest possible selling price must be negotiated. One needs to compare the prices that other businesses charge for the same product or service.
A smaller profit margin in the short term could ensure a more sustainable profit in the long term.
The value of advertising and marketing campaigns must not be underestimated. These can be very expensive so the benefits must be weighed up against the costs.
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