Profitability ratios Cambridge IGCSE Accounting revision
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In plain words
A profit of $20 000 sounds good. Is it? It depends whether it came from sales of $50 000 or $500 000, and whether $40 000 or $4 million was invested to earn it. Ratios turn raw figures into ones that can be compared.
6 things to know
- Gross profit margin = gross profit ÷ revenue × 100. It shows how much gross profit is made from each $100 of sales.
- Profit margin = profit for the year ÷ revenue × 100. It shows how much is left from each $100 of sales after all the expenses.
- Return on capital employed (ROCE) = profit for the year before interest ÷ capital employed × 100. It shows how well the money invested in the business is being used.
- Capital employed = issued shares + reserves + non-current liabilities. For a sole trader it is the owner's capital plus non-current liabilities.
- Mark-up = gross profit ÷ cost of sales × 100.
- All of these are percentages. In each case, a higher figure is better.
Worked example
A business has revenue of $200 000, gross profit of $70 000 and a profit for the year of $24 000 after charging loan interest of $2000. Capital employed is $130 000. Calculate the three ratios.
- Gross profit margin = 70 000 ÷ 200 000 × 100 = 35%.
- Profit margin = 24 000 ÷ 200 000 × 100 = 12%.
- Profit before interest = 24 000 + 2000 = 26 000. ROCE = 26 000 ÷ 130 000 × 100 = 20%.
Tips and tricks
- Write the formula in words first, then the figures, then the answer with its % sign. Each of the three earns a mark.
- For ROCE, add the interest back to the profit. Use only the formulas in the syllabus: others are not accepted.
It lands in your notebook with its questions as flashcards.
Profitability ratios: 5 questions and answers
These are the quiz’s questions. Do the quiz first, then come back here for the ones that got you.
Which formula gives the gross profit margin?
Margins are measured against revenue.
Revenue is $60 000 and the profit for the year is $9000. What is the profit margin?
9000 ÷ 60 000 × 100.
Which profit figure is used to calculate ROCE?
Interest is added back, because the loans are part of the capital employed.
Which of these is included in capital employed?
Capital employed is the long-term funding: equity plus non-current liabilities.
The gross profit margin has stayed at 40% but the profit margin has fallen from 15% to 10%. What is the most likely cause?
Gross profit is unchanged, so the fall happened after it: in the expenses.
Quiz
5 questions
Tap an answer and you’ll see straight away whether it’s right, and why.
Worksheet
3 questions, 7 marks. Write your answers on paper, then check them.
Profitability ratios
Cambridge IGCSE Accounting 0452 · 7 marks · papermunch.org
Name ______________________________ Date ______________
Revenue is $150 000 and gross profit is $45 000. Calculate the gross profit margin.[2]
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30%. 45 000 ÷ 150 000 × 100.
The profit for the year is $18 000 after loan interest of $1500. Owner's capital is $100 000 and there is a long-term loan of $30 000. Calculate the return on capital employed.[3]
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15%. Profit before interest = 19 500. Capital employed = 130 000. 19 500 ÷ 130 000 × 100.
Revenue is $80 000 and the profit for the year is $6000. Calculate the profit margin.[2]
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7.5%. 6000 ÷ 80 000 × 100.
Answers: Profitability ratios
- 1. 30%. 45 000 ÷ 150 000 × 100.
- 2. 15%. Profit before interest = 19 500. Capital employed = 130 000. 19 500 ÷ 130 000 × 100.
- 3. 7.5%. 6000 ÷ 80 000 × 100.