Profitability Ratios (Cambridge (CIE) IGCSE Accounting)

Exam Tip

The gross margin must be less than 100%. If you get an answer bigger than 100% then check your working.

Worked Example

Kaley is a sole trader. She provides the following information for the year ended 31 December 2023.

Calculate Kaley's gross margin. Your answer should be correct to two decimal places.

Answer

• Calculate the cost of sales

  • Opening inventory + Purchases - Closing inventory

  • $8 000 + $52 000 - $6 000 = $54 000

• Calculate the gross profit

  • Revenue - Cost of sales

  • $128 000 - $54 000 = $74 000

• Calculate the gross margin

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• Round to two decimal places

  • Gross margin = 57.81%

Exam Tip

The mark-up can be bigger than 100% so do not worry if your answer is bigger than 100%.

Worked Example

Kaley is a sole trader. She provides the following information for the year ended 31 December 2023.

Calculate Kaley's profit margin. Your answer should be correct to two decimal places.

Answer

• Calculate the profit for the year

  • Gross profit + Other income - Expenses

  • $74 000 + $9 000 - $46 000 = $37 000

• Calculate the profit margin

  • 
    

  • 

• Round to two decimal places

  • Profit margin = 28.91%

Exam Tip

Notice that this profitability ratio uses the operating profit rather than the profit for the year. This means you need to use the profit before finance costs (loan interest or debenture interest).

Worked Example

The equity and liabilities of Khazam Ltd at 31 December 2023 are listed below.

The profit for the year ended 31 December 2023 was $35 000 after charging debenture interest.

Calculate the return on capital employed for the year ended 31 December 2023. The calculation should be correct to two decimal places.

Answer

• Calculate the debenture interest for the year

  • 5% × $30 000 = $1 500

• Calculate the operating profit for the year

  • Add the debenture interest back onto the profit for the year

  • $1 500 + $35 000 = $36 500

• Calculate the capital employed

  • Equity (Share capital + Reserves + Retained earnings) + Non-current liabilities

  • $140 000 + $40 000 + $50 000 + $30 000 = $260 000

• Calculate the return on capital employed

  • 

  • 

• Round to two decimal places

  • ROCE = 14.04%

Worked Example

Sana and Taz are business partners. They provide information for the financial years ending 31 December 2022 and 31 December 2023.

Comment on the performance of the business over the two years.

Answer

• Comment on the gross margin

The gross margin has improved from 32.25% to 43.75%. This could be because Sana and Taz increased the selling prices of their goods. They could have decreased the cost of sales by changing to a cheaper supplier.

• Comment on the profit margin

The profit margin has improved from 9.43% to 10.31%. This could be due to a higher gross profit, but it could also be due to an increase in other income.

• Comment on the differences between the gross and profit margins

In 2022, the difference between the gross and profit margins was 22.82%. In 2023, this difference was 33.44%. The difference worsened, which could be because Sara and Taz had worse control over their expenses.

• Comment on the return on capital employed

The return on capital employed worsened from 21.08% to 10.45%. This could be due to an increase in the capital employed. This may have involved more capital being introduced by the partners or a long-term loan.