What is Average Profit?
Average profit is an approach to identifying the profit margin that is achieved on each unit of a product that is sold. This is accomplished by considering the relationship between the expenses associated with producing, marketing, and selling the unit, and the price that a buyer pays for that unit. Average profit can also refer to the gross profit margin that is achieved by a business within a specified period of time, such as one calendar year. In both applications, the idea is to get an idea of how much return is actually generated by the sale of each unit, and determine if that return is in fact more than all expenses associated with the effort.
The easiest way to understand how an average profit is calculated is to consider both the costs of production and the funds that are expended in a marketing or advertising campaign. This usually requires that historical data regarding the effectiveness of the campaign must be analyzed to determine how many sales actually generated from that effort. Assuming that an advertisement in a magazine cost $1,000 in US dollars (USD) and yielded a total of one thousand sales, the advertising cost per unit would be $1 USD. If each unit costs a total of $2 USD to produce, this comes to a total of $3 USD that has been invested in the production and the promotion of each unit.
If the manufacturer sells each unit for a price of $5 USD, this means that the average profit per unit sold is $2 USD. As a result, the sale of those one thousand units results in profits of $2,000 USD for the manufacturer. In this scenario, the realization of this level of profits indicates that the business is doing well with both its production costs and in its choice of promotion strategies.
Determining average profit is important to the ongoing success of any business. Since the costs for raw materials and other resources that go into the production of the goods or services can fluctuate, a business owner will monitor those expenses closely. Depending on the circumstances, the owner may be able to order raw materials in larger quantities and secure a lower price as a result of the volume purchase. The business owner may also look at current advertising methods and determine if there is an equally effective advertising strategy that will cost less while still resulting in the same amount of sales. Doing so helps to increase the average profit, and makes the prospect of continuing to produce units of a given product much more appealing.
Investors who are interested in acquiring a business will also want to look closely at the average profit generated by that company. Along with providing important information regarding the level of profitability the business currently enjoys, the figures also provide valuable clues into how well the business and its assets are managed. If the average profit is healthy and the operation is efficient, the chances of the investor earning a steady return from the acquisition are much better.
Discuss this Article
Post your comments