Blog Reader Question: Business Interruption Gross Profit Calculation
I received the following question from a reader and reproduce it and my answer below for you all:
Dear Mr Manning,
There is something I may be missing in the calculation of Gross Profit under the BI policy.
The policy states:
the amount by which:
(a) the sum of the Turnover and the amount of the Closing Stock and Work in Progress shall exceed
(b) the sum of the amount of the Opening Stock and Work in Progress and the amount of the Uninsured Working Expenses as set out in the Schedule.
Why does it start with the opening stock?
Closing stock less production plus opening stock will give as a result production available for sale. If the Gross Profit I need to know refers to products sold then I calculate, for example, the cost of raw materials used in the product sold as: Opening stock of raw materials plus raw materials purchased less Closing stocks opening stock. The resulting amount less turnover will comprise all costs and expenses from which I deduct not insurable cost and expenses. I shall be obliged if can explain me the policy definition and if I am wrong or missing something.
Thank you very much for the attention you may give to this query-
Carlos [last name and email withheld]
I replied to Carlos as follows:
We add closing stock to the turnover to the business to get one figure.
From this new combined figure you deduct the sum on opening stock and the expenses, such as purchases you do not need to insure.
If I am reading your question right you are asking about opening and closing stock.
What the formula is doing is looking to include the difference in the opening and closing stock as this is another form of profit.
For example if a business was to increase its stock level from say $50,000 at purchase price at the start of the accounting period to $100,000 at the end. The value of the business if everything else stayed the same would be $50,000 more. ($100,000 closing stock -$50,000 opening stock)
This is profit to the company. One way to look at it, is, that the business chose to invest in more stock so they could provide a better service (faster or offer wider range than before). Whatever the reason this increase in stock is profit in the form of stock instead of cash but it is still valuable acne still profit reinvested in the form of stock.
I hope this helps.