Accounting - Term 4 - Week 6

Imagine Thandi runs a spaza shop in Khayelitsha. She wants to know if her business is truly making money, not just surviving. Like many South African entrepreneurs, she faces load-shedding and rising costs. Profitability indicators help her see if her hard work is paying off. For example, gross profit percentage shows how much profit she makes from sales after paying for stock. If Thandi buys cold drinks for R10 each and sells them for R15, her gross profit is R5 per drink. The gross profit percentage is (Gross Profit ÷ Sales) × 100, so (R5 ÷ R15) × 100 = 33,3%. This means for every rand she earns, about 33 cents is profit before expenses. These indicators are crucial for decision-making, loan applications, and attracting investors. Many learners think profit is just money left after sales, but it’s vital to separate gross profit (before expenses) and net profit (after all expenses).

Sipho owns a tuck shop at a school in Soweto. He wants to check if his business is as profitable as last year. First, he calculates gross profit percentage: Gross Profit ÷ Sales × 100. If his sales are R20 000 and cost of sales is R12 000, gross profit is R8 000. Gross profit percentage is (R8 000 ÷ R20 000) × 100 = 40%. Next, he calculates net profit percentage: Net Profit ÷ Sales × 100. If his net profit after all expenses is R3 000, then (R3 000 ÷ R20 000) × 100 = 15%. This tells Sipho that after paying for stock and all other expenses (like rent and electricity), he keeps 15 cents out of every rand. Many learners confuse gross and net profit percentages. Remember: gross profit is before expenses, net profit is after all expenses.

Lerato invested R50 000 in a small salon in Polokwane. At year-end, her net profit is R8 000. She wants to know if her investment is working harder than a savings account. Return on owner’s equity (ROE) is Net Profit ÷ Average Owner’s Equity × 100. If her average owner’s equity for the year is R50 000, then ROE is (R8 000 ÷ R50 000) × 100 = 16%. This means for every R100 she invested, she earned R16 profit this year. If a bank savings account offers 7% interest, Lerato’s business is doing better. A common misconception is to use closing equity only, but always use the average equity for the year (opening plus closing divided by 2) for accuracy.

Ahmed and his cousin run two similar internet cafés in Durban. Ahmed’s gross profit percentage is 35%, net profit percentage is 10%, and ROE is 12%. His cousin’s ratios are 40%, 15%, and 18%. Comparing these, Ahmed’s cousin is more profitable in all areas. But why? Maybe his cousin negotiated better prices for stock or controls expenses better. When interpreting ratios, always look for reasons behind the numbers: higher gross profit could mean better pricing or lower stock costs; higher net profit could mean lower expenses. In NSC exams, you may be asked to compare two businesses and justify which is performing better, using these indicators.

Step 1: Find sales and cost of sales. Example: Sales = R50 000, Cost of Sales = R30 000. Step 2: Calculate gross profit: R50 000 - R30 000 = R20 000. Step 3: Calculate gross profit percentage: (R20 000 ÷ R50 000) × 100 = 40%. Step 4: Find net profit (after all expenses). Example: Net Profit = R7 500. Step 5: Calculate net profit percentage: (R7 500 ÷ R50 000) × 100 = 15%. Final answers: Gross profit percentage is 40%, net profit percentage is 15%. Quick check: Net profit percentage must always be less than gross profit percentage because expenses always reduce profit after gross profit is calculated. If your net profit percentage is higher than your gross profit percentage, you have made a calculation error.

Step 1: Find net profit and average owner’s equity. Example: Net Profit = R12 000. Opening equity = R80 000, Closing equity = R100 000. Step 2: Calculate average owner’s equity: (R80 000 + R100 000) ÷ 2 = R90 000. Step 3: Calculate ROE: (R12 000 ÷ R90 000) × 100 = 13,3%. Step 4: Interpret the result: This means for every R100 invested by the owner, the business generated R13,30 profit this year. Final answer: Return on owner’s equity is 13,3%. Quick check: Always compare ROE to other investment options, like bank interest rates, to judge if the business is performing well. If you used only the closing equity, your answer would be inaccurate.

Question: A minibus taxi business in Mthatha has sales of R120 000 and cost of sales of R72 000. What is the gross profit percentage? Let’s think: First, subtract cost of sales from sales: R120 000 - R72 000 = R48 000 (gross profit). Next, divide gross profit by sales: R48 000 ÷ R120 000 = 0,4. Multiply by 100 to get the percentage: 0,4 × 100 = 40%. So, for every rand earned, 40 cents is gross profit before expenses. Now you try: Sales = R90 000, Cost of Sales = R54 000. What is the gross profit percentage? Answer: (R36 000 ÷ R90 000) × 100 = 40%. This shows the business is consistent in its profitability.

Question: Sipho’s shop has a net profit percentage of 12%. Lerato’s salon has 18%. Who is more profitable, and why? Model: Compare the percentages. Lerato’s is higher, so her business keeps more profit from sales. This could be due to lower expenses or better pricing. In an exam, you would write: 'Lerato’s salon is more profitable because her net profit percentage is higher, meaning she earns more profit per rand of sales.' Now you try: Ahmed’s net profit percentage is 8%, his cousin’s is 14%. Who is more profitable? Answer: Ahmed’s cousin, because 14% is higher than 8%. This means Ahmed’s cousin is keeping more profit from each rand of sales.

1. Define gross profit percentage in your own words. 2. State the formula for return on owner’s equity, showing all parts clearly. 3. List two reasons why a business owner would want to know their net profit percentage. 4. Give one example of a South African business that would use these indicators. 5. Explain the difference between gross profit and net profit.

1. Calculate the gross profit percentage if sales are R60 000 and cost of sales is R36 000. 2. Calculate net profit percentage if net profit is R6 000 and sales are R60 000. 3. Calculate return on owner’s equity if net profit is R9 000 and average owner’s equity is R75 000. 4. If a business’s net profit percentage drops from 20% to 10%, what could be the reason? 5. Explain why a business might have a high gross profit percentage but a low net profit percentage.

1. Compare two businesses: Business A has a gross profit percentage of 45% and net profit percentage of 10%. Business B has 40% and 15%. Which is more profitable overall and why? 2. Interpret what it means if a business’s net profit percentage drops from 20% to 12% in one year. 3. Justify whether a return on owner’s equity of 8% is good if the bank offers 7% interest. 4. Solve: Calculate the ROE if net profit is R15 000, opening equity is R100 000, and closing equity is R110 000. 5. Predict how increasing expenses would affect the net profit percentage.

• Profit after all expenses
• Profit from sales before expenses
• Total sales as a percentage of profit
• Owner’s equity growth

Answer: Profit from sales before expenses

Gross profit percentage measures profit before expenses. Many confuse it with net profit, which is after expenses.

• 40%
• 60%
• 50%
• 30%

Answer: 40%

Gross profit is R32 000. (R32 000 ÷ R80 000) × 100 = 40%. Some may mistakenly use cost of sales instead of gross profit, which would give an incorrect answer.

• Net Profit ÷ Sales × 100
• Gross Profit ÷ Owner’s Equity × 100
• Net Profit ÷ Average Owner’s Equity × 100
• Net Profit ÷ Total Assets × 100

Answer: Net Profit ÷ Average Owner’s Equity × 100

Return on owner’s equity uses net profit and the average owner’s equity (opening plus closing divided by 2) to show how much profit is earned for every rand invested by the owner. Many learners confuse this with net profit percentage or use only the closing equity, which is incorrect.

• Expenses are low
• No expenses were paid
• Expenses reduced profit
• Sales are too high

Answer: Expenses reduced profit

The gap between gross and net profit percentages shows the impact of expenses. If net profit percentage is much lower, it means expenses are high. Some may think sales are the problem, but it’s actually the expenses that reduce profit after gross profit is calculated.

• Increasing expenses
• Raising selling prices
• Buying more stock at higher prices
• Reducing sales

Answer: Raising selling prices

Higher selling prices increase profit per sale, which can boost net profit percentage if expenses stay the same. Increasing expenses or the cost of stock would reduce net profit percentage, while reducing sales would also lower profit.