Financial Ratios (Profitability)

Question 1

What is profitability?

Answer 1

Ability to earn profits.

Question 2

State the profitability ratios.

Answer 2

1. Gross profit margin
2. Gross profit mark up
3. Profit margin
4. Expenses as a % of net sales revenue
5. Returns on equity

Question 3

Give the formula for gross profit margin.

Answer 3

GP Margin = [Gross Profit / Net Sales Revenue] X 100

Question 4

Give the formula for gross profit markup.

Answer 4

GP Markup = [Gross Profit / Cost of Sales] X 100

Question 5

Give the formula for profit margin

Answer 5

Profit margin = [Profit /Net Sales Revenue] X 100

Question 6

Give the formula for Expenses as a % of Net Sales Revenue

Answer 6

[Expenses / Net Sales Revenue] X 100

Question 7

Give the formula for returns on equity

Answer 7

[Profit / Average Equity] X 100

Question 8

What does GP Margin of 40% mean?

Answer 8

For each dollar of NSR, business made a gross profit of 40 cents.

Question 9

What does GP Markup of 30% mean?

Answer 9

For each dollar of cost of sales, business made a gross profit of 30 cents.

Question 10

Convert GP markup of 33.33% to GP margin.

Answer 10

33.33/133.33 = 25%

Question 11

What does profit margin of 12% mean?

Answer 11

For each dollar of net sales revenue, business made a profit of 12 cents.

Question 12

A business made a gross profit of

$28 000. The cost of sales was $56 000. What is the GP margin

Answer 12

GP margin = [28 000 / (28000+56000)] X 100

= 33.33%

Question 13

Explain return on equity of 8%.

Answer 13

For each dollar invested, the investor earned 8 cents.

Question 14

Business A earned a GP margin of 30% and a profit margin of 5%. Explain what it means.

Answer 14

For each dollar of NSR, the business earned a gross profit of 30 cents and a profit of 5 cents. Business spent 25 cents of each dollar of NSR on expenses.

Question 15

Business A has a GP margin of 30% and Business B has a GP margin of 20%. What could have been the cause of difference, given that they are in the same industry?

Answer 15

A high margin is due to either high selling price or a low cost of sales.

• Business A might have set a higher selling price than B.
• Business A might have a lower cost due to good relationship with supplier or bulk purchase of inventory
• Business B might be having a special promotion and thus sell at a lower price
• Business A might be established and able to sell at high price as it has loyal customers.

Question 16

What consideration must be taken for meaningful comparison of two businesses?

Answer 16

1. businesses should be in the same industry
2. accounting period should be the same
3. both absolute and relative figures should be considered