Recap: Profitability

To price for a mark-up, add the percentage to the cost.

To price for a margin, work back from the selling price. For a margin of 40%, the cost is the other 60% of the price, so the price is cost ÷ 0.6.

A bike lock costs Fernhill £12 before VAT.

Capital employed is the long-term money tied up in the business: the owner's capital plus any long-term loans.

Return on capital employed, or ROCE, is profit as a percentage of that money: profit before loan interest ÷ capital employed × 100.

Fernhill has no loans. Its capital employed is Priya's capital of £200,000, and its profit for the year is £40,000.

Owners compare ROCE with what the same money could earn elsewhere. A business is riskier than a savings account, so it should earn more.

Rent was 9% of sales last year and 7% this year, although the rent itself rose by £1,000.

A cost that stays much the same whatever the sales, such as rent, takes a smaller share as sales grow.

A cost that takes a bigger share than before has grown faster than sales, and deserves a closer look. Wages went from 17% of sales to 18%. Other expenses fell in pounds while sales rose.

Capital employed is the long-term money tied up in the business: the owner's capital plus any long-term loans.

Return on capital employed, or ROCE, is profit as a percentage of that money: profit before loan interest ÷ capital employed × 100.

Fernhill has no loans. Its capital employed is Priya's capital of £200,000, and its profit for the year is £40,000.

Owners compare ROCE with what the same money could earn elsewhere. A business is riskier than a savings account, so it should earn more.

The percentages fit together. Gross profit margin less total expenses as a percentage of sales gives the net profit margin.

Fernhill's gross margin was 45% last year and 40% this year. Total expenses were 33% of sales last year and 30% this year.

The net margin rises when the business keeps more of each £1 of sales.

• Raise prices without losing sales
• Pay less for the goods
• Spend less on running costs

Being paid sooner, or paying suppliers at a different time, moves cash. It does not change profit.

A margin can also set a target. Sales × the margin wanted gives the profit needed.