# 6.1 Calculating profit

For a window manufacturer, the key is to establish whether total revenue from the sale of windows exceeds the total costs incurred in its provision for sale. If the windows are manufactured (as opposed to bought in ready for resale), the gross profit would be calculated as follows. (Figures and dates are assumed for the sake of this example.)

## Table 8 Gross profit calculation for the year ending 31 December 2024

| £
--- | ---
Sales | 2,000,000
Less: Cost of production | (1,800,000)
Gross profit | Total 200,000

This calculation uses the sales and the cost of goods sold, which includes labour and material costs incurred as well as production indirect costs to arrive at the gross profit (or loss). However, as a basis for the day-to-day management of the factory, it provides us with only a limited insight into the company’s performance.

## Activity 7 Performance information

Allow around 5 minutes for this activity

What is it about this information that restricts us to a limited view of the company’s performance?

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If you want to use this performance information, you need more details. Decision makers need either disaggregated information or information that is organised and rendered useful. The information needs to be viewed in context if it is to be useful. For example, one essential piece of information is a sense of scale – how many windows were sold? Let us assume that 20,000 windows were sold. This information allows us to start analysing the company’s performance in a more meaningful way. Assuming that exactly 20,000 windows were produced during the year, we can now create a far more informative report than before.

The following report gives us a starting point for measuring the factory’s detailed financial performance.

## Table 9 Gross profit calculation for the year ending 31 December 2024

| £ | Per window £
--- | --- | ---
Sales | 2,000,000 | 100
Less: Cost of production | (1,800,000) | 90
Gross profit | 200,000 | 10

Let us assume that all the windows were of the same specification and that inflation has not distorted the figures. From this information we can easily establish that the average selling price was £100 and that each window cost an average of £90 to produce.

As a result, management can see that every unit made an average gross margin or gross profit of £10. This information can then be used for planning purposes. Is that enough per window? Is it enough gross profit overall – to cover expenses and result in an overall net profit? Can the gross profit be increased – either per window or overall?

In the simple case of the window manufacturer, only when information about sales revenue, costs (including costs of production) and, therefore, gross and net profit per window, is available, does it become possible for management to consider revising its pricing, production levels and cost plans. Such individual unit cost information is vital for internal decision making (e.g. pricing) in the normal multi-product firm or in a services firm where different types of service offering are provided.

OpenLearn - Fundamentals of cost accounting and environmental management accounting
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