Profit & Profitability (AQA A Level Business): Revision Note

Profit versus cash

• Profit and cash are two very different measures

  • A business can be profitable on paper and still be unable to pay its bills

  • Equally, a business can have plenty of cash in the bank while actually making a loss

What is profit?

• Profit is the amount left over from a business's revenue once all costs have been deducted

• It measures the overall financial performance of the business over a period of time — typically a month, a quarter, or a financial year

Example

A business earns £5,000 from a project but spends £2,000 on materials, software, and marketing. Its profit is £3,000.

• Profit is recorded in the income statement and is calculated based on when income is earned and costs are incurred

  • This is not necessarily when the money actually moves in or out of the bank

  • Banks and investors typically use profit to assess the long-term financial health and viability of a business

Types of profit

• Types of profit are covered in more detail here

What is cash?

• Cash is the money a business has available at any given moment

  • The balance in its bank account and any other immediately accessible funds

• A business needs sufficient cash coming in at the right time to meet its outgoings — wages, rent, supplier payments and other day-to-day costs

Example

A business checks its bank account and sees a balance of £5,000. That is its cash position right now, regardless of whether a customer invoice is due next week or a supplier payment goes out tomorrow.

Why profit and cash differ

Examples of differences

• A business completes a large project in March and records the profit immediately

  • However, the customer does not pay until May

  • The profit exists on paper; the cash does not yet exist in the bank

• A business pays upfront for equipment and stock before any revenue is earned

  • Cash falls, but profit is not immediately affected in the same way

• A business pays a large quarterly tax bill

  • This is a significant cash outflow that does not reduce profit in the same period

Why a profitable business can run out of cash

• If a business has high sales on paper but customers are slow to pay, the business may not have enough cash to cover wages, rent or supplier invoices as they fall due, even though it is technically profitable

Common causes of cash deficits

• Late payment from customers

  • Money owed but not yet received

• Rapid growth

  • Expanding quickly requires cash for stock, staff and premises before the extra revenue arrives

• Seasonal demand

  • Revenue is uneven across the year but fixed costs must be paid every month

• Large upfront costs

  • Investing in equipment or premises reduces cash immediately, even if the long-term return is positive

• A business with strong profit but poor cash flow management can collapse despite being commercially successful

• Equally, a business with a large cash balance may still be losing money over time if its costs consistently exceed its revenue

Profitability

• Profitability is a measure of how efficiently a business converts its revenue or the resources it has invested into profit

  • It is expressed as a percentage, allowing comparisons to be made between businesses, time periods or industry benchmarks

Profitability versus profit

• Profit is an absolute figure

  • It shows how many pounds a business has made after costs are deducted.

• Profitability is a relative figure

  • It shows how much profit the business makes in relation to its revenue or investment

• The distinction matters because a large profit does not automatically mean a business is performing well

Example

Business A makes a profit of £500,000 from revenue of £10,000,000

Business B makes a profit of £500,000 from revenue of £2,000,000

• Both have earned the same profit in pounds

• Business B is far more profitable as it is generating the same return from a fraction of the revenue.

• Measures of profitability are covered in more detail here