Understanding Business

We saw in the previous chapter that one way of earning an income is the “profit” from a business. What is a business? It is easier to understand the idea of a business with a simple example.

Suppose you live in a city with a wholesale vegetable market situated at the outskirts of the city. Wholesale market is the place where farmers bring large quantities of vegetables from their farms to sell them to merchants. Merchants buy a variety of vegetables from several farmers and sell them to you and me in the vegetable market in the city.

You realize that the price of tomatoes in the wholesale market is cheaper than the price in the city market. So you also decide to become one such merchant. You may buy 50 kgs of tomatoes at Rs 10 per kg, bring it to the city market and sell them at Rs 12 per kg. Then you used Rs 500 to buy 50 kgs of tomatoes which you sold for Rs 600 (50 kgs @ Rs 12 per kg). Then you have an excess of Rs 100 with you, which can be called the profit that you have made in that business transaction. It can also be considered as your income.

It is not necessary that you always make a profit. It is possible that at the city market, many merchants like you have brought tomatoes and they are now available for a price of Rs 9 per kg. Since tomatoes can go bad if kept overnight, you may be forced to sell at Rs 9. In such a case you had to sell all your tomatoes for Rs 450. So you had Rs 500 when you went to the wholesale market and at the end of the day you have Rs 450 with you. In this case you have made a loss of Rs 50. So you can say that you had no income on that day.

Several aspects of the above business can be seen.

1. The price of vegetables both at the wholesale market and the city market can change from day to day and even from hour to hour. If there is less quantity of a vegetable on a day, merchants will try to sell it at a higher price. Similarly, if there is a larger quantity in a day, merchants will try to sell their stock by reducing the price.

2. Your ability to make a profit or loss depends on the changing prices of tomatoes which can change from day to day or even hour to hour. Hence your intelligence in estimating the price of tomatoes in the future may also decide your profit or loss.

3. You may incur some expenses for transporting the vegetables from the wholesale market to the city market. These expenses also have to be considered while calculating your profit or loss.

You also need to understand some vocabulary to communicate about various aspects of business.

1. Price at which you sell a product (vegetables in the above example) is Selling price. The total amount which you make by selling all the products is your Sale Amount

2. Price at which you purchased the product is Purchase Price. The total amount you spent on purchasing is called Purchase Cost

3. Profit is the difference between the Sale Amount and the Purchase Cost

4. The expenses which you incur for completing the transaction are the Expenses. They may include the cost of your travel to the wholesale market, cost of bringing the product to the city market etc.

5. We could call the Profit in (c ) as Gross Profit. The Profit left after incurring the Expenses can be called Net Profit.

6. If your Purchase Cost is more than the Sale Amount, you have made a Loss.

All the above aspects are measured ultimately in terms of money I,e rupees & paise. In your house, possibly your father or mother notes down the various expenses and income in a notebook. Who does that work in a business? That person is the “accountant”.

The accountant uses a system based on math to keep track of the income and expenses. This system is called “double entry” accounting. Accountants have to study a special course called “chartered accounting” and “cost accounting” after school.