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Profitability ratios
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Profitability ratios show how well a business turns sales and investment into profit. You must be able to calculate and interpret them.
The formulae
Gross profit margin (%) = gross profit × 100 ÷ revenue
Operating profit margin (%) = operating profit × 100 ÷ revenue
Mark-up (%) = profit per item × 100 ÷ cost per item
ROCE (%) = operating profit × 100 ÷ capital employed (return on capital employed)
Operating profit margin (%) = operating profit × 100 ÷ revenue
Mark-up (%) = profit per item × 100 ÷ cost per item
ROCE (%) = operating profit × 100 ÷ capital employed (return on capital employed)
Margin versus mark-up
An item costs £40 and sells for £50. Profit per item = £10.
Mark-up = 10 × 100 ÷ 40 = 25% (profit compared with cost).
Margin = 10 × 100 ÷ 50 = 20% (profit compared with selling price).
Mark-up = 10 × 100 ÷ 40 = 25% (profit compared with cost).
Margin = 10 × 100 ÷ 50 = 20% (profit compared with selling price).
Interpreting
Higher is generally better for all four.
Compare with previous years and with other businesses in the same industry.
ROCE shows how well the business uses its long-term finance: compare it with the interest rate on savings.
Compare with previous years and with other businesses in the same industry.
ROCE shows how well the business uses its long-term finance: compare it with the interest rate on savings.
Operating profit is £60 000 and capital employed is £400 000. Find the ROCE.
- ROCE = 60 000 × 100 ÷ 400 000
Answer: 15%
GPM = gross profit × 100 ÷ revenue. OPM = operating profit × 100 ÷ revenue. Mark-up = profit per item × 100 ÷ cost per item. ROCE = operating profit × 100 ÷ capital employed. Compare over time and with rivals.
Check you have got it
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