Ch 5 Profit Analysiss

8/8/2019 Ch 5 Profit Analysiss

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Profit Analysis

By

Kanchana Iyer


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Introduction

Reward to the entrepreneur

It may be negative

It can be expressed in different ways

according to the rationale.

It is the residual income and not the

contractual income Highly fluctuating


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Types of Profit

Gross Profit and Net Profit:

GP: Excess of revenue over all explicit payments.(wages, taxes, depreciation)

NP: Its is also known as pure profit. Implicit Costs hasto be deducted from Gross Profit to arrive for NetProfits.

Normal and Super Normal Profit:

NP: Profits necessary to remain in the operation (Min) SNP: It is the residual surplus over explicit costs,

implicit costs and normal profits.


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Types of Profit

Accounting Profit and Economic Profit:

AP: It is the revenue obtained during the

period minus the cost and expenses incurred toproduce the goods responsible for getting the

revenue.

EP: It take into account both explicit and

implicit costs. It reflects true profitabilityposition of the business enterprise.


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Theories of Profit


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RiskTheory of Profit

Given by Prof Hawley

Profit as a reward for venturing into

something risky. Higher the risk, higher the reward.

Businesses are speculative in nature andtherefore reward is necessary for the riskbearer.

Profit is the risk premium


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Uncertainty Theory of Profit

Given by Prof F H Knight

Risks are inherent factors of business but can bedivided into insurable and non insurable risks.

The insurable risks are predictable and can beinsured and the insurance premium becomes apart of the price / costs

Only the non insurable risks become responsiblefor emergence of profits.

Uncertainty bearing rather than risk bearingimportant


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Dynamic Theory of Profit

Given By Prof Clark

Dynamic economy leads to constant changes indemand and supply force and leads to constant

change in the profit / loss conditions. The dynamics leads to the profits which is again

a temporary phenomena.

Dynamic changes can be introduced by the firm

also, in the form of mew technology, product,process, ad, salesmanship etc and this can lead tochange in the level.


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Innovation Theory of Profits

Prof Schumpeter:

Profit is both cause and effect of

innovation Innovation brings change in consumers

tastes and preferences

When innovation becomes obsolete, profitsdisappear.


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Profit for organizing other

factors of Production An entrepreneur is responsible for

coordinating infrastructures, men ,machine

etc and the profit is reward for his skill inmanaging all the resources.

It is a payment for the efficient and

effective utilization to the optimum pointof the resources in order to reach the target

or goal


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Objectives of a firm

Profit maximization

Sales maximization

Revenue Maximization Industry leadership

Cost control

Maintain liquidity

Consumer goodwill

Fight competition


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Profit Measurement

Rate of return on capital:

Net profit * 100

Fixed capitalLow returns do not always indicate low profits

but sometimes indicate the high overheads

among which the profits get distributed

Graph:


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Equilibrium of the firm

Profit = TR TC

Condition of maximization: First order derivative

should be 0 dr - dc = 0

dq dq

dr = dc

dq dq

MR = MC


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Cost Volume Profit Analysis

Profit Sales Volume ofCosts Production

The revenue generated depends on market

conditions, competitors, taste of consumerswhich are external therefore not alwayscontrollable.

On the other hand, the profits can be controlled

by controlling the costs which is related to thevolume of production. (that is why the analysis isknown as CVP relations


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Cost Volume Profit Analysis

CVP Analysis gives a picture profit levelsof activity.

Volume is usually expressed in terms ofsales capacity expressed as a percentage ofmaximum sales, volume of sales, unit ofsales etc

It will involve volume of sales. Price,product mix of sales, variable costs,overhead costs


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Objectives of CVP analysis

To know the relationship bet profits and

costs as well bet profit and volume.

To know and set costs (budgets) at variouslevel of activity.

To evaluate performance for control

To formulate price policies.


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Profit- Volume Ratio

P/V ratio = Marginal Contribution /Sales

or

Sales value Variable CostsSales value

Sales value Variable Costs

Sales value

Fixed Cost + Profit

Sales Value


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Break Even Analysis

It relates revenue, costs and total profits ofthe firm at various levels of output

BEP point is that volume of sales wherethe firm the total costs will be equal to totalrevenue.

It is the point of 0 profit

BEP = Fixed Costs

Selling Price Variable Costs


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Assumptions

Perfect distinction of costs into fixed and

variable costs

Whatever is produced is sold (Production =Sales)

Revenue is perfectly variable with

production (Straight Line) Stable Product Mix


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Utility

Effect of Pricing Policy

Product Method and its impact on costs/rev

To adjust cost and revenue to achieve thetargeted profits

Better margin of profit betweenalternatives.

Level of production to be maintained toearn quick profits.

http://wwwbizedacuk


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BE Chart

http://www.bized.ac.uk

Break-Even AnalysisCosts/Revenue

Output/Sales

FC

VCTCTR TR

Q1


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Implications

Both cost and revenue curve are linear

curve. (Constant variable costs and

constant MR) Effect of change in Price

Effect of change in VC

Effect of change in FC In a non linear function


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Contribution Margin

Total Contribution Profit : Difference

between total revenues and total variable

costs. On a per unit basis , it is equal to

difference between the price and average

variable costs.


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Advantages

To determine optimum level of output

To decide the ideal production level (capacity)

To choose projects from alternatives To know the impact of changes in price and costs

on profits.

To know the pricing policy

Situations like hire or purchase, add or drop,

expand or divert.

Ch 5 Profit Analysiss

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