Thursday, December 04, 2003

Analysis of the Year-to-Year Change in Net Profit After Tax   It is useful to analyze the changes in net profit from one year to the next. This gives you insights as to what has happened in the business. Net Profit is what’s left over after deducting Direct Expenses and Overheads from Gross Profit. Gross Profit from one year to the next arises because of three things:   1. A change in the volume as reflected by the number of transactions. 2. A change in Average Transaction Value due to pricing or transaction size. 3. A change in the cost of sales.         The relationship between these is shown below: x Average Transaction Value minus Average Cost of Sales minus = Gross Profit minus Direct Expenses + Enterprise Overheads = Net Profit The Change in Gross Profit The analysis of the change in Gross profit from one year to the next frequently reveals that additional revenue has had a positive impact but this is more than lost by a reduction in the Gross profit margin. This should be looked at very carefully.     6:20:49 PM

The Six Drivers of Business Profitability There are 6 drivers of net profit. They are: 1. Average prices 2. Average transaction size (that is, the number of units per transaction) Together 1 and 2 make Average Transaction Value. 3. Number of transactions Total revenue is equal to Average Transaction Value x Number of Transactions. Drivers 1, 2 and 3 determine revenue. Most times you will not be able to easily isolate the Average Price and Transaction Size unless you have access to the detailed transactions. However, if you know the total Number of Transactions (or a close approximation is always good enough for a high level analysis) you can work with Average Transaction Value (drivers 1 and 2 combined). 4. Average cost of goods sold Cost of Goods Sold is a variable cost in the sense that it varies directly with the volume of revenue. Gross Profit is the difference between Total Revenue and Total Cost of Goods Sold. It is the amount left after variable costs have been covered. The Gross Profit % is equal to Gross Profit / Total revenue. 5. Direct expenses These are enterprise overheads that are directly associated with, and can be easily traced to, the revenue generating activities of a business. They may be variable but are usually fixed in the sense that they are not driven by revenue. For example, if a retail business had 5 stores, the costs directly associated with each store (as opposed to those that are associated with the business as a whole) would be classified as direct costs. In a business that has only one store, you might want to classify non-variable sales and marketing expenses as direct. 6. Enterprise overheads Enterprise overheads are all other expenses not classified as part of COS or Direct Expenses. These are expenses necessarily incurred in running the business.   6:19:15 PM