Gross profit is $30 000 and revenue is $150 000. What is the gross profit margin?

20%. 30 000 ÷ 150 000 × 100 = 20%.

Profit is $18 000 and capital employed is $120 000. What is the ROCE?

15%. 18 000 ÷ 120 000 × 100 = 15%.

Which ratio shows how much profit is earned from the money invested in a business?

return on capital employed. It compares profit with capital employed.

A business's profit margin has risen from 6% to 9%. This means that

more of each dollar of revenue is being kept as profit. A higher margin is more profit for each dollar of sales.

Why should a business compare its ratios with those of earlier years?

to see whether its performance is improving or getting worse. One year's figure says little without something to set it against.

Profitability ratios · Cambridge IGCSE Business Studies

In plain words

A profit of $1 million sounds impressive, until you learn that the business needed sales of $100 million to make it. To judge how well a business is doing, profit has to be compared with something: its sales, or the money invested in it.

That comparison, written as a percentage, is a profitability ratio.

5 things to know

Gross profit margin = gross profit ÷ revenue × 100.
Profit margin = profit ÷ revenue × 100. When operating profit is used, it is called the operating profit margin.
Return on capital employed (ROCE) = profit ÷ capital employed × 100. It shows how much profit each dollar invested in the business earns.
Mark-up = gross profit ÷ cost of sales × 100.
A ratio means little alone. Compare it with the previous year's, or with a competitor's.

Worked example

A business has revenue of $400 000, gross profit of $120 000, profit of $40 000 and capital employed of $250 000. Calculate its three ratios.

Gross profit margin = 120 000 ÷ 400 000 × 100 = 30%.
Profit margin = 40 000 ÷ 400 000 × 100 = 10%.
ROCE = 40 000 ÷ 250 000 × 100 = 16%.

Tips and tricks

Margin is profit as a percentage of revenue. Mark-up is profit as a percentage of cost. The same sale gives two different figures, so check which is asked for.
A falling gross profit margin points to the cost of sales or the selling price. A falling profit margin, with the gross margin steady, points to the expenses.

5 questions, about 2 minutes.

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.

Gross profit is $30 000 and revenue is $150 000. What is the gross profit margin?
- 5%
- 20% (the answer)
- 25%
- 50%
30 000 ÷ 150 000 × 100 = 20%.
Profit is $18 000 and capital employed is $120 000. What is the ROCE?
- 6.7%
- 12%
- 15% (the answer)
- 18%
18 000 ÷ 120 000 × 100 = 15%.
Which ratio shows how much profit is earned from the money invested in a business?
- gross profit margin
- current ratio
- return on capital employed (the answer)
- acid test ratio
It compares profit with capital employed.
A business's profit margin has risen from 6% to 9%. This means that
- its sales have fallen
- more of each dollar of revenue is being kept as profit (the answer)
- its costs have risen faster than its revenue
- it has more cash
A higher margin is more profit for each dollar of sales.
Why should a business compare its ratios with those of earlier years?
- to change its prices at once
- to see whether its performance is improving or getting worse (the answer)
- to pay less tax
- to hide its results
One year's figure says little without something to set it against.

5 questions

Tap an answer and you’ll see straight away whether it’s right, and why.

Worksheet

4 questions, 11 marks. Write your answers on paper, then check them.

Profitability ratios

Cambridge IGCSE Business Studies 0450 · 11 marks · papermunch.org

Name ______________________________ Date ______________

State the formula for the gross profit margin.[2]
Show answerHide answer
Gross profit margin = gross profit ÷ revenue × 100.
I got this one
A business has revenue of $250 000 and a profit of $20 000. Calculate its profit margin.[3]
Show answerHide answer
Profit margin = 20 000 ÷ 250 000 × 100 = 8%.
I got this one
A business makes a profit of $36 000 with capital employed of $300 000. Calculate its ROCE and explain what the figure means.[3]
Show answerHide answer
ROCE = 36 000 ÷ 300 000 × 100 = 12%. Each $100 invested in the business earned $12 of profit in the year.
I got this one
A business's gross profit margin stays at 40% but its profit margin falls from 15% to 9%. Explain what this suggests.[3]
Show answerHide answer
The cost of sales has not risen relative to revenue, so the fall must come from higher expenses, such as rent, wages or advertising.
I got this one

Answers: Profitability ratios

1. Gross profit margin = gross profit ÷ revenue × 100.
2. Profit margin = 20 000 ÷ 250 000 × 100 = 8%.
3. ROCE = 36 000 ÷ 300 000 × 100 = 12%. Each $100 invested in the business earned $12 of profit in the year.
4. The cost of sales has not risen relative to revenue, so the fall must come from higher expenses, such as rent, wages or advertising.