Is 5.31% good?: Lena works out her 2025 profit margin: 5.31% (3.5.1). Out of every $1 of sales, the bakery keeps about 5 cents as profit before interest and tax.
Is that good?: On its own, the number cannot say. A ratio means something only next to another figure: the same ratio in earlier years, or the same ratio for businesses like hers.
Lena starts with her own past. She lines up the last three years of accounts, side by side (comparing over time, or trend analysis).
| Lena's Bakery Ltd | 2023 | 2024 | 2025 |
|---|---|---|---|
| Sales revenue | $1,400,000 | $1,500,000 | $1,600,000 |
| Cost of sales | $420,000 | $450,000 | $480,000 |
| Gross profit | $980,000 | $1,050,000 | $1,120,000 |
| Expenses | $840,000 | $930,000 | $1,035,000 |
| Profit before interest and tax | $140,000 | $120,000 | $85,000 |
| Gross profit margin | 70.00% | 70.00% | 70.00% |
| Profit margin | 10.00% | 8.00% | 5.31% |
Reading the trend, step by step
Say which way each ratio moved, and how far
The gross profit margin held at 70.00% in all three years.
The profit margin fell every year, from 10.00% to 8.00% and then 5.31%: 4.69 percentage points in two years.
Read the two ratios together
A steady gross profit margin means ingredients still cost 30 cents of every $1 of sales: Lena's prices kept up with her flour bills.
So the fall happened below gross profit, in the expenses.
Find the line that moved
Expenses rose by 23.21%, from $840,000 to $1,035,000, while sales rose by only 14.29%. Wages and salaries alone went from $600,000 to $750,000.
Say what it means
The bakery sells more every year but keeps less of each dollar. Profit before interest and tax fell from $140,000 to $85,000, and it will keep falling if expenses keep growing faster than sales.
Percentage points or per cent?: The profit margin fell from 10.00% to 5.31%. Subtract, and it fell by 4.69 percentage points.
As a share of where it started, that is almost half: 4.69 ÷ 10.00 × 100 = 46.88%. Both are right if you say which one you mean. 'It fell by 4.69%' is neither.
Three years show a direction. Two years can show a one-off, like Valley Grain's flood repair (3.3.3): one bad year that says nothing about the next. The longer the run of figures, the surer the trend.
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The trend tells Lena her margin is falling. It does not tell her whether 5.31% is poor for a bakery or normal.
For that she needs businesses like hers, and the same ratios for them (comparing with rivals, or inter-firm comparison).
Where the rivals' figures come from: Goldcrust plc publishes its accounts, so Lena can read them (3.4.3). Most small bakeries are privately held and publish nothing.
So Lena uses the averages that the bakers' trade association works out from its members' accounts every year (an industry average): the typical small bakery, in numbers.
| 2025 | Lena's Bakery Ltd | Average for small bakeries | What it says |
|---|---|---|---|
| Gross profit margin | 70.00% | 60.00% | Lena keeps more of each dollar after ingredients: her bread sells at a better price for what goes into it |
| Profit margin | 5.31% | 8.00% | Her lead disappears in the expenses: they take 64.69 cents of each $1 of sales, against 52 cents for the average |
| Return on capital employed | 12.14% | 15.00% | Each $1 invested in the bakery earns less profit than in the typical small bakery |
| Current ratio | 1.33 | 1.20 | Better placed than most to pay the bills due in the next few months |
| Acid test ratio | 1.08 | 0.80 | Even without selling her stock she could pay them |
A fair comparison
- A business of about the same size
- In the same trade, selling to the same kind of customer
- For the same year, so both faced the same flour prices
Why Goldcrust is not one
- It runs 400 bakeries and buys flour by the trainload, so its costs per loaf are far lower
- It sells cheaper bread through supermarkets, a different market
- Its margins show what size does, not how well three shops are run
Why even the average needs care
- An average hides the best and the worst bakeries
- A bakery that rents its ovens has less capital employed, so its ROCE looks higher
- It says where Lena differs, not why
One ratio never decides: Against the average, Lena is ahead on gross profit margin and on both liquidity ratios, and behind on profit margin and return on capital employed.
Read together, they point to one place: the expenses. That is where the strategies of 3.5.1 would start.
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A ratio asks a question: Lena's profit margin fell from 10.00% to 5.31% and is below the average for small bakeries. That tells her where to look.
What it does not tell her: It does not tell her why it happened, or what to do about it. Every ratio has things it cannot show (its limitations).
Six things a ratio cannot show
Why it changed
The accounts show wages rising faster than sales. They cannot say whether that was a pay rise that keeps Priti's best bakers, or more hours on the night shift than the bakery needs.
What happens next
The 2025 accounts describe a year that is over. The $45,000 deck oven, the Station Road shop and next year's flour price are not in them.
Any day but one
The current ratio uses the balance sheet on 31 December. On 30 December Lena could use $15,000 of cash to clear the overdraft: current assets $65,000, current liabilities $45,000, a current ratio of 1.44 instead of 1.33.
On 2 January she uses the overdraft again. Arranging the figures to look good on that one day is window dressing.
Anything not counted in money
The skill of the bakers, the queue at seven every morning, what customers say about the bread, how the staff feel. None of it is in the accounts, so none of it is in a ratio.
The world outside
A poor wheat harvest, a new rival on the High Street, a recession. A ratio shows the result, not whether the cause was inside the bakery or outside it.
A like-for-like comparison, always
Rivals may value their ovens differently or end their year in a different month. And when prices rise across the economy (inflation), sales grow every year even if no more loaves are sold.
Limits are not a reason to ignore ratios: They are a reason to look further: at the accounts behind the ratio, at what the managers know, and at the things that are not counted in money.
A ratio points to the question. The rest of the case answers it.
So a good comment on ratios does three things: it says what moved, with the figures; it gives the most likely reason from the case; and, when the question gives room, it says what the figures leave out.
How this comes up: A table of ratios for two or three years, then a short question.
The short question
- Comment on the gross profit margin and the profit margin, for two marks.
- Or explain one reason why the two margins moved apart, for two.
In a longer case: The same table comes back in a discussion of a plan to improve profitability, and the plan has to be judged with the figures.
The two-mark comment
- Say what the figures show, using every year in the table: which way each ratio moved, and how far.
- Read the two ratios together. Both falling points to cost of sales or prices; only the profit margin falling points to expenses.
- Say what it means, with a reason from the case: costs not passed on to customers, expenses growing faster than sales.
Repeating the table is not a comment: 'The gross profit margin was 70% every year and the profit margin was 10.00%, 8.00% and 5.31%' copies the table. At best it is the basic mark.
The second mark needs an interpretation with the data: what the numbers mean for the business, and why they moved.
Using the table, comment on Lena's Bakery Ltd's gross profit margin and profit margin for 2023 to 2025.
Model answer plan
See the answer broken into clear points, with guidance on how each point earns marks.