Profitability ratios
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Question
What is the NPM formula?
Answer
NPM = (Net profit ÷ Sales revenue) × 100
💡 Hint
NP over Revenue × 100
Question
State both profitability ratio formulas
Answer
GPM = (GP ÷ Revenue) × 100. NPM = (NP ÷ Revenue) × 100.
💡 Hint
GP/Rev and NP/Rev × 100
Question
What is the GPM formula?
Answer
GPM = (Gross profit ÷ Sales revenue) × 100
💡 Hint
GP over Revenue × 100
Question
What do profitability ratios measure?
Answer
How effectively a business turns revenue into profit — expressed as a percentage of revenue.
💡 Hint
Revenue → profit efficiency
Question
Revenue $500k, COGS $300k, Expenses $150k. Calculate GPM and NPM.
Answer
GP=$200k, GPM=40%. NP=$50k, NPM=10%. Gap suggests high overheads.
💡 Hint
GP=200k, NP=50k
Question
High GPM but low NPM suggests what?
Answer
Overheads eating into gross profit — trading is fine but the business has an expense problem.
💡 Hint
Overhead problem
Question
What is the 4-step approach for ratio questions?
Answer
Calculate → State → Interpret → Suggest improvements. Earns top marks.
💡 Hint
Calc → State → Interpret → Suggest
Question
Revenue $200k, NP $20k. Calculate NPM.
Answer
($20k ÷ $200k) × 100 = 10%. The business keeps 10 cents profit per dollar.
💡 Hint
20/200 × 100
Question
How to improve GPM?
Answer
Reduce COGS (cheaper suppliers, bulk buying) or raise selling prices.
💡 Hint
COGS down or prices up
Question
Revenue $200k, GP $80k. Calculate GPM.
Answer
($80k ÷ $200k) × 100 = 40%. Means 40 cents of every dollar covers expenses and profit.
💡 Hint
80/200 × 100
Question
Both GPM and NPM declining — what does this signal?
Answer
Serious concern — less profitable at both trading and overall level.
💡 Hint
Danger at both levels
Question
Why are ratios more useful than raw profit figures?
Answer
They allow meaningful comparisons between years and businesses of different sizes.
💡 Hint
Percentages level the field
Question
GPM 40%, NPM 10%. What does the 30pp gap mean?
Answer
30% of revenue consumed by expenses — overheads are high relative to revenue.
💡 Hint
Overheads consuming 30%
Question
$100k profit on $10m revenue — is this good?
Answer
No — only 1% margin. Raw profit needs context; ratios reveal the real picture.
💡 Hint
1% margin
Question
What does a high GPM indicate?
Answer
The business earns well on each sale after direct costs — efficient at buying/selling.
💡 Hint
Good trading efficiency
Question
How does NPM differ from GPM?
Answer
NPM deducts ALL costs (overheads, interest, tax), not just COGS. It's the 'bottom line'.
💡 Hint
All costs, not just direct
Question
GPM measures ___ efficiency; NPM measures ___ efficiency
Answer
GPM = TRADING efficiency. NPM = OVERALL efficiency.
💡 Hint
Trading vs overall
Question
How to improve NPM beyond GPM?
Answer
Cut overheads (rent, waste) and increase sales volume to spread fixed costs.
💡 Hint
Cut overheads + volume up
Question
Higher margins = better. What must you always compare with?
Answer
Previous years (trends) and competitors (benchmarks). A ratio alone is meaningless.
💡 Hint
Time + rivals
Question
Name two ways to improve GPM
Answer
Increase selling prices (if demand allows) or reduce COGS (cheaper suppliers, bulk buying).
💡 Hint
Price up or COGS down
Question
Why must you never just calculate a ratio?
Answer
Interpretation is worth more marks than the calculation — always explain what the number means.
💡 Hint
Interpretation > calculation
Question
Name two ways to improve NPM beyond GPM methods
Answer
Reduce overheads (renegotiate rent, cut waste) and increase sales volume to spread fixed costs.
💡 Hint
Cut overheads + sell more
Question
Why analyse both margins together?
Answer
Reveals whether problems are in trading (COGS) or overheads — pinpoints where to fix.
💡 Hint
Pinpoint the problem area
Question
Name the two IB profitability ratios
Answer
Gross Profit Margin (GPM) and Net Profit Margin (NPM).
💡 Hint
GPM and NPM
Question
'40 cents of every dollar' — what does this GPM phrase mean?
Answer
After paying for COGS, 40 cents from each dollar of revenue remains for expenses and profit.
💡 Hint
What's left after direct costs
Question
Why can ratios compare a corner shop with a multinational?
Answer
Percentages make size irrelevant — both can be compared on efficiency.
💡 Hint
Size-neutral comparison
Question
Low GPM suggests what kind of problem?
Answer
A pricing or COGS problem — not enough made on core sales.
💡 Hint
Price too low or COGS too high
Question
GPM specifically measures what type of efficiency?
Answer
Trading efficiency — how much is left from each sale after paying direct costs (COGS).
💡 Hint
Trading efficiency
Question
Quick recall: High GPM + Low NPM = ?
Answer
Overhead/expense problem — trades well but spends too much on running costs.
💡 Hint
Overhead problem
Question
Why is NPM called the 'bottom line'?
Answer
Net profit appears at the bottom of the income statement — after ALL costs deducted.
💡 Hint
Last line on the statement
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