The financial information for the business that has been calculated also shows that the business is a viable investment. After calculating a cash flow forecast a profit and loss account was able to be pieced together and it shows that the business should make an estimated £15,813.20 profit per year. This is despite the extra costs that occur during the first few months/years of operation such as mortgage repayments and loan repayments. This is quite a substantial profit for the opening 12 months and it is hoped that the business would be able to make more profit in the second 12 months as costs are reduced.
Other information that shows the business is viable is the Profitability Ratios. One of the profitability ratios is the Gross Profit Margin. This shows how much profit is earned relative to the amount that is spent. Gross profit is Sales Revenue – Cost of Sales. These costs of sales are materials such as stock and wages. The gross profit is before the other costs are subtracted. The Gross Profit Margin is important as it shows how well a business can control its production costs. The Gross Profit Margin is calculated the following way.
Gross Profit Margin = Gross Profit
__________ X 100
Sales Revenue
The Gross Profit Margin for the business is calculated in the following way:
28,296
______ X 100
95,760
= 30%
This figure shows that the business is able to control its production costs well. A Gross Profit Margin of 30% shows that for every £100 spent on production costs £30 is made in Gross Profit.
Another profitability ratio that can be used is the Net Profit Margin. Net Profit is Gross Profit – Expenses so it takes into account all the costs that a business will have to pay. It is also the amount of profit after tax.
The Net Profit Margin is calculated in the following way:
Net Profit Margin = Net profit
________ X 100
Sales Revenue
The Net Profit Margin for the business is:
15,813.20
________ X 100
95,760
=17%
This figure shows that for every £100 spent on the business £17 is made in profit. This figure may not seem a lot but considering all the costs that the business has to pay when first in operation this is a very fair figure. In time when debts such as loans and mortgages are paid off I would expect Net Profit Margin to increase. This means that the business will be more profitable.
Return on Capital Employed shows the amount that is earned in relation to the amount that is invested in the business. ROCE is useful as it shows how well managers are performing. This information is useful to shareholders because if the ROCE is very low then a change of manager may be needed to ensure that shareholders make money from investing.
The ROCE is calculated in the following way:
ROCE=Net Profit
________ X 100
Net Assets
The ROCE for the business is:
15,813.20
________ X 100
130,000
=12%
This shows that for every £100 that is put into the business £12 is made in profit. This figure is quite poor however taking into consideration the business owns the premises it will be operating from it is clear why ROCE is 12%. The premises are worth £130,000. If the business rented a property ROCE would be much higher however running costs would be greater meaning that the Gross and Net Profit Ratios would be smaller.
Overall the Profitability Margins show that the business is very viable. Gross Profit of 30% and Net Profit of 17% show that the business is efficient and makes a substantial amount of profit. The business is also a viable investment when the fact that some costs will be reduced as time goes on. This will mean that Net Profit Margins will increase.
