Analyse profitability ratios
Calculate gross profit margin, operating profit margin and ROCE, interpret them in context, and assess ways to improve profitability.
Section 10.2 · Analysis of published accounts
Cambridge International AS & A Level Business 9609, 2026–2028 syllabus and 2029 syllabus, section 10.2.2. Ratio calculations use the formulae listed in the relevant Cambridge syllabus. Written practice is self-checked. Specialist review has not been completed for this lesson; these exercises do not award an official mark or establish exam readiness.
Before you begin
- Read the figures, dates and assumptions supplied in the question before calculating or interpreting an accounting result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What profit numerator does Cambridge prescribe for ROCE?
What you will learn
- Explain profitability and the measures of margin and return
- Use Cambridge's exact formulae for margins and ROCE
- Interpret trends and assess improvement strategies
Margins and returns answer different questions
Gross profit margin (%) = gross profit ÷ revenue × 100. Operating profit margin (%) = profit from operations ÷ revenue × 100. Return on capital employed (ROCE, %) = profit from operations ÷ capital employed × 100; capital employed = issued shares + reserves + non-current liabilities.
Gross margin shows the proportion remaining after cost of sales. Operating margin also reflects operating expenses. ROCE compares operating profit with long-term capital invested. Cambridge calls the latter margin 'profit margin' in the content outline and gives operating profit margin in its formula list; use the supplied data and prescribed formula.
A ratio is a clue, not a verdict
Compare with prior periods, similar businesses and the firm's aims, while checking prices, product mix, cost changes, investment and accounting policies. A margin may rise because price increased, costs fell or the mix changed; it does not explain the cause by itself.
Possible actions include reviewing price, waste, purchasing, productivity and product mix. Higher prices may reduce volume; cutting staff or maintenance can damage quality; a capital investment may initially lower ROCE while building future capacity. Tie a recommendation to evidence and likely time horizon.
Pause and explain
Gross profit is $90,000 and revenue is $300,000. What is gross profit margin?
Worked example
A company reports revenue $500,000, gross profit $175,000, profit from operations $60,000, issued shares $180,000, reserves $60,000 and non-current liabilities $60,000. Calculate its margins and ROCE.
Show the worked solution
- Gross margin=175,000÷500,000×100=35%.
- Operating margin=60,000÷500,000×100=12%.
- Capital employed=180,000+60,000+60,000=$300,000; ROCE=60,000÷300,000×100=20%.
Answer Gross profit margin is 35%, operating profit margin 12%, and ROCE 20%.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Revenue is $800,000, gross profit $280,000, profit from operations $96,000 and capital employed $480,000. Calculate both margins and ROCE.
Give me a hint
Use revenue for both margins and capital employed for ROCE.
Compare my reasoning
- Gross margin=280,000÷800,000×100.
- Operating margin=96,000÷800,000×100.
- ROCE=96,000÷480,000×100.
Gross profit margin=35%; operating profit margin=12%; ROCE=20%.
Look for these in your work
- Both margins use revenue
- Operating profit is used in operating margin
- ROCE uses capital employed
A business raises its gross margin but operating margin falls. Give two possible explanations and one piece of evidence needed before recommending a response.
Give me a hint
The ratios are affected by different cost layers and sales composition.
Compare my reasoning
- Gross margin may rise through price or lower cost of sales.
- Operating expenses may have risen faster, or the product mix may have changed.
- Inspect product-level sales and cost/expense data over the same period.
The business may have improved price or direct purchasing costs, raising gross margin, while higher staff, rent, marketing or other operating expenses lowered operating margin. Product mix could also change both. Compare like-for-like products, volumes and expense data before deciding whether to cut costs or change prices.
Look for these in your work
- Different statement layers are distinguished
- At least two causes are plausible
- Evidence is tied to the diagnosis
ROCE falls after a factory expansion, although operating profit rises slightly. Explain one reason and assess whether the investment should be reversed.
Give me a hint
ROCE can fall if capital employed rises faster than operating profit; assess strategy and future returns.
Compare my reasoning
- New equipment or buildings raise capital employed.
- A small profit rise may not yet offset the larger denominator.
- Consider utilisation, ramp-up time, forecasts, financing and alternative uses of capital.
The expansion may increase capital employed substantially before full output or profit arrives, reducing current ROCE even as operating profit edges up. It is not enough to reverse the investment on this ratio alone: assess demand, ramp-up, capacity use, future cash flows, strategic fit and whether the assumptions still hold.
Look for these in your work
- Denominator effect is explained
- Short-run and long-run effects are separated
- Decision uses context rather than one ratio
Common mistakes
- Using profit for the year instead of profit from operations in ROCE
- Omitting reserves or non-current liabilities from capital employed
- Treating a higher percentage as automatically better without context
What can you explain now?
What profit numerator does Cambridge prescribe for ROCE?
Compare with the explanation
Profit from operations
ROCE compares operating return with capital employed.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Which numerator and denominator belong in each Cambridge profitability ratio, and why compare more than one period?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.