Profitability Ratios

Question 1

Gross Profit Margin % and why variance in GPM may occur?

Answer 1

Gross Profit / Sales Revenue x 100

Variances caused by:
- Selling prices
- Sales mix
- Items incl. in purchases (e.g. trade discounts).
- Items incl. in production cost.
- Inventory (obsolescence, shortages).
- Errors in Inventory Valuation.

Question 2

Net Profit Margin % and what it means

Answer 2

PBIT / Sales Rev x 100

• High NProfit Margin means:
  Costs are under control.
  Sales prices are high.

Question 3

ROCE

Answer 3

ROCE = PBIT / Capital Employed x 100

• Capital Employed = Shareholders Funds + LT Liabilities
  or Net assets + NCL

Question 4

Return on equity (%) definition & calculation

Answer 4

• Amount of net income returned as a % of shareholder equity.
  Shows how much profit a company makes with the shareholder’s money.

PBIT / Equity x 100

Question 5

Asset Turnover Calculation, Definition and how to increase it?

Answer 5

Revenue / Capital Employed
- E.g. 8 times = £8 of rev. for £1 of assets.

• Capital Employed = Shareholders Funds + LT Liabilities
  or Net assets + NCL

How efficiently assets are being used to generate revenue.

• Increase AT by increasing sales volume without investing in more assets.

Question 6

Limitations of ROCE

Answer 6

• Measures the return against the book value of assets (depreciated value).
  As these are depreciated, the ROCE will increase even though cash flow has remained the same.