Profitability ratios Cambridge IGCSE Business Studies (9–1) revision
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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.
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?
30 000 ÷ 150 000 × 100 = 20%.
Profit is $18 000 and capital employed is $120 000. What is the ROCE?
18 000 ÷ 120 000 × 100 = 15%.
Which ratio shows how much profit is earned from the money invested in a business?
It compares profit with capital employed.
A business's profit margin has risen from 6% to 9%. This means that
A higher margin is more profit for each dollar of sales.
Why should a business compare its ratios with those of earlier years?
One year's figure says little without something to set it against.
Quiz
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 (9–1) 0986 · 11 marks · papermunch.org
Name ______________________________ Date ______________
State the formula for the gross profit margin.[2]
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Gross profit margin = gross profit ÷ revenue × 100.
A business has revenue of $250 000 and a profit of $20 000. Calculate its profit margin.[3]
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Profit margin = 20 000 ÷ 250 000 × 100 = 8%.
A business makes a profit of $36 000 with capital employed of $300 000. Calculate its ROCE and explain what the figure means.[3]
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ROCE = 36 000 ÷ 300 000 × 100 = 12%. Each $100 invested in the business earned $12 of profit in the year.
A business's gross profit margin stays at 40% but its profit margin falls from 15% to 9%. Explain what this suggests.[3]
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The cost of sales has not risen relative to revenue, so the fall must come from higher expenses, such as rent, wages or advertising.
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.