Using Profitability Ratios To Analyse Performance (Cambridge (CIE) IGCSE Business): Revision Note

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731

Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022

(2)

Step 1: Substitute the values into the formula

$$\begin{gathered} \mathrm{Gross}\mathrm{profit}=\frac{\mathrm{Gross}\mathrm{profit}}{\mathrm{Sales}\mathrm{revenue}}\times 100 \\ =\frac{\$105,731}{\$124,653} \\ =0.8482 \end{gathered}$$   [1]

Step 2: Multiply the outcome by 100 to find the percentage

$$\begin{gathered} =0.8482\times 100 \\ =84.82\% \end{gathered}$$      [1]

• 84.82% of Head to Toe Wellbeing’s revenue was converted into gross profit during 2022

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its profit before interest and tax was $65,864

Calculate Head to Toe Wellbeing Ltd’s Profit Margin in 2022

(2)

Step 1: Substitute the values into the formula

$$\begin{gathered} \text{Net profit margin = }\frac{\mathrm{Profit}\mathrm{before}\mathrm{interest}\mathrm{and}\mathrm{tax}}{\mathrm{Sales}\mathrm{revenue}}\times 100 \\ =\frac{\$65,864}{\$124,653} \\ =0.5284 \end{gathered}$$    [1]

Step 2: Multiply the outcome by 100 to find the percentage

$$\begin{gathered} =0.5284\times 100 \\ =52.84\% \end{gathered}$$     [1]

• In 2022, 52.84% of Head to Toe Wellbeing’s revenue was converted into profit before interest and tax

The table shows an extract from the company accounts of Keals Cosmetics.

Calculate Keals Cosmetics' Return on Capital Employed.         

(3)

 Step 1: Calculate the capital employed   

$$\begin{gathered} \mathrm{Capital}\mathrm{employed}=\mathrm{Non}-\mathrm{current}\mathrm{liabilities}+\mathrm{Equity} \\ \mathrm{Capital}\mathrm{employed}=€1.5\mathrm{m}+€15.4\mathrm{m} \\ \mathrm{Capital}\mathrm{employed}=€16.9\mathrm{m} \end{gathered}$$   [1]

Step 2: Divide Operating Profit by Capital Employed

$$\begin{gathered} \mathrm{RoCE}=\frac{\mathrm{Profit}\mathrm{before}\mathrm{interest}\mathrm{and}\mathrm{tax}}{\mathrm{Capital}\mathrm{employed}}\times 100 \\ =\frac{€2.2\mathrm{m}}{€16.9\mathrm{m}}\times 100 \\ =0.13 \end{gathered}$$  [1]

Step 3: Multiply the result by 100 and express the outcome as a percentage

$$\begin{gathered} =0.13\times 100 \\ =13\% \end{gathered}$$   [1 mark]

• Capital employed in Keals Cosmetics has generated a return of 13%

Faced with increasing costs, Kent & Medway Properties Ltd is looking to close one of its three high-street estate agency branches.

The table below shows some key data for each of the branches.

Calculate the Return on Capital Employed (RoCE) for each branch and recommend which branch, on profitability terms, should close.

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Step 1: Apply the formula to calculate the RoCE for each branch

      $$\begin{gathered} \mathrm{RoCE}=\frac{\mathrm{Profit}\mathrm{before}\mathrm{interest}\mathrm{and}\mathrm{tax}}{\mathrm{Capital}\mathrm{employed}}\times 100 \\ \mathrm{RoCE}\mathrm{Sevenoaks}=\frac{\pounds 0.37\mathrm{m}}{\pounds 2.4\mathrm{m}}\times 100=15.42\% \end{gathered}$$ [1]

$\mathrm{RoCE}\mathrm{Whitstable}=\frac{\pounds 0.57\mathrm{m}}{\pounds 3.1\mathrm{m}}\times 100=18.39\%$ [1]

$\mathrm{RoCE}\mathrm{Rochester}=\frac{\pounds 0.51\mathrm{m}}{\pounds 2.9\mathrm{m}}\times 100=17.59\%$ [1]

Step 2: Identify the least profitable branch for closure

• Sevenoaks is the least profitable branch with a RoCE of 15.42% and should be the branch selected for closure   [2]

When calculating financial ratios check that you are using the correct units.

In some cases financial data is presented as raw figures (e.g. £14,520) but in most cases, you will be working in thousands (£000) or millions (£m).

• Ensure that you convert correctly, e.g. £0.39 million is equal to £390,000 and £34.9 (000) is equal to £34,900

• Make sure the decimal place is in the correct place

• Calculate to two decimal places unless stated otherwise