There are three (3) profitability or performance ratios. Gross profit margin, profit margin and return on capital employed.
Gross Profit Margin (GPM)
GPM measures the amount of gross profit earned as a proportion of revenue. They can determine how much percentage of profit is earned from sales. By comparing gross profit margin year-on-year, a business can measure if cost of sale has increased or decreased. Therefore, higher gross profit margin will indicate higher profit generated from revenue.
Profit Margin (PM)
Profit margin on the other hand measures the profit before tax earned as a proportion of revenue. It helps determine the percentage of profit earned from sales after all expenses. By comparing profit margin year-on-year, a business can determine if expenses have increased or reduced compared to the revenue generated. Higher profit margin means, higher profit generated from revenue after expenses.
By comparing the difference between GPM and PM, you can determine if there is a need to reduce expenses (fixed cost) to increase profit. Not sure how? Comment below
RELATED CONCEPTS
Profit
Revenue
Expenses
PAST YEAR QUESTIONS
Do you think Paul should be worried about the change in the profit margins between 2016 and 2017? Justify your answer. (6 marks) Feb/Mar 2018/12
Do you think a firm's performance has improved in 2017? Justify your answer using profit margins. (6 marks) May/June 2018/11
What is meant by ‘return on capital employed’? (2 marks) May/June 2019/11
What is meant by ‘capital employed’? (2 marks) Oct/Nov 2019/12
Define ‘Return on Capital Employed’. (2 marks) May/June 2020/13
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