Finance: Revenue, Costs, Profit, Margins and ARR
Calculation questions are guaranteed marks if you know the formulas and show your working. For AQA GCSE Business 8132 you need revenue, costs and profit, gross and net profit margins, and the average rate of return, all of which appear below with fully worked examples.
Revenue, costs and profit
The three core formulas are:
- Revenue = selling price x quantity sold
- Total costs = fixed costs + variable costs
- Profit = revenue - total costs
Worked example: a cafe sells 1,200 meal deals in a month at £4.50 each. Each meal deal costs £1.75 in ingredients and packaging (variable cost), and the cafe pays £1,800 a month in rent, salaries and insurance (fixed costs).
| Step | Calculation | Result |
|---|---|---|
| Revenue | 1,200 x £4.50 | £5,400 |
| Variable costs | 1,200 x £1.75 | £2,100 |
| Total costs | £2,100 + £1,800 | £3,900 |
| Profit | £5,400 - £3,900 | £1,500 |
Fixed costs stay the same whatever the output; variable costs rise and fall with the number sold. Mixing them up is the most common calculation error at GCSE.
Gross and net profit margins
Margins turn profit into a percentage of revenue, so businesses of different sizes can be compared.
- Gross profit = revenue - cost of sales, and gross profit margin (GPM) = gross profit / revenue x 100
- Net profit = gross profit - other expenses, and net profit margin (NPM) = net profit / revenue x 100
Using the cafe above: gross profit = £5,400 - £2,100 = £3,300, so GPM = 3,300 / 5,400 x 100 = 61.1%. Net profit = £3,300 - £1,800 = £1,500, so NPM = 1,500 / 5,400 x 100 = 27.8%.
Real businesses run much thinner margins at scale: Greggs reported revenue of £2,014 million and pre-tax profit of £203.9 million in 2024, a margin of about 10.1%. A falling GPM points to rising ingredient costs or price cutting; a falling NPM with a steady GPM points to rising overheads such as rent and wages.
Average rate of return (ARR)
The average rate of return compares the profit from an investment with its cost, so different projects can be ranked:
- ARR (%) = average annual profit / cost of investment x 100
- Average annual profit = total profit over the project's life / number of years
Worked example: the cafe considers spending £40,000 on new coffee machines expected to add the following profit over five years: £4,000, £5,000, £6,000, £7,000 and £8,000.
| Step | Calculation | Result |
|---|---|---|
| Total profit | 4,000 + 5,000 + 6,000 + 7,000 + 8,000 | £30,000 |
| Average annual profit | £30,000 / 5 | £6,000 |
| ARR | 6,000 / 40,000 x 100 | 15% |
The result is judged against alternatives: other projects, the interest the money could earn in a bank, and the cost of borrowing. ARR ignores when the money arrives, so a project with early profits may be preferred even if its ARR is slightly lower.
Key terms
Practice questions
State the formula for calculating net profit margin. [2 marks]
Model answer guidance: Net profit margin equals net profit divided by revenue, multiplied by 100. It is expressed as a percentage. It shows how much of each pound of revenue is kept as net profit.
A clothing shop has revenue of £48,000 and cost of sales of £30,000. Calculate the gross profit margin. Show your working. [3 marks]
Model answer guidance: Gross profit = £48,000 - £30,000 = £18,000. Gross profit margin = 18,000 / 48,000 x 100. The gross profit margin is 37.5%.
A business invests £20,000 in new equipment with an average annual profit of £3,500. Calculate the average rate of return. Show your working. [3 marks]
Model answer guidance: ARR = average annual profit divided by cost of investment, times 100. That is 3,500 / 20,000 x 100. The average rate of return is 17.5%.
Analyse what a falling gross profit margin might tell the owner of a bakery. [6 marks]
Model answer guidance: A falling GPM means the gap between selling prices and the cost of ingredients is shrinking. This could be because flour, butter or energy costs have risen while prices stayed the same, or because the bakery has been discounting to keep customers. Either way, each sale now contributes less towards fixed costs, so the owner should investigate whether to raise prices, find cheaper suppliers or change the product mix before net profit is squeezed too.
A cafe owner can invest £40,000 in either Project A, new coffee machines with an ARR of 15%, or Project B, a delivery service with an ARR of 11% but higher profits in the first year. Recommend which project the owner should choose. Justify your answer. [12 marks]
Model answer guidance: On ARR alone, Project A wins: 15% beats 11%, meaning each pound invested earns more profit on average, and both beat leaving the money in the bank. However, ARR ignores timing, and Project B returns cash sooner, which matters if the cafe's cash flow is tight, since early profits can be reinvested or cover unexpected costs. The decision also rests on risk and fit: machines improve an existing, proven operation, while delivery enters a new market where forecasts are less certain. Overall I would recommend Project A, because its higher return comes from strengthening what the cafe already does well and the profit figures are easier to trust; Project B is only preferable if the owner urgently needs cash in year one.
Examiner tips
- Always show your working in calculation questions; a correct method earns marks even when the final answer slips.
- Include the units and the percentage sign in your final answer, and round sensibly, usually to one decimal place.
- When comparing investments, mention what ARR ignores, especially the timing of profits, to reach the higher evaluation levels.
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