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Profitability ratios
Edexcel IAL Accounting · WAC11 The Accounting System and Costing
Profitability ratios show how well a business turns revenue and capital into profit. The formulae are not given in the exam, so learn them exactly as Appendix 7 of the specification states (spec 1.5.1).
The four profitability ratios
| Ratio | Formula | Example |
|---|---|---|
| Gross profit as % of revenue (gross margin) | Gross profit / revenue x 100 | 84,000 / 240,000 = 35.00% |
| Percentage mark-up | Gross profit / cost of sales x 100 | 84,000 / 156,000 = 53.85% |
| Profit for the year as % of revenue | Profit for the year / revenue x 100 | 30,000 / 240,000 = 12.50% |
| Return on capital employed (ROCE) | Profit before interest / capital employed x 100; capital employed = capital + non-current liabilities | (30,000 + 2,000) / (144,000 + 40,000) = 17.39% |
Interpreting them
- Gross margin falls if selling prices are cut (to win sales or match competitors) or purchase costs rise and are not passed on; it rises with better buying, higher prices or a shift to higher-margin goods.
- Mark-up moves in the same direction as margin but is always the larger figure.
- Profit for the year % also reflects control of expenses: if gross margin is steady but this ratio falls, expenses have risen faster than revenue.
- ROCE compares profit with the long-term funds used; compare it with the return from a safe alternative (such as bank interest) and with competitors. For a sole trader, remember the owner's own salary is not deducted, so profit includes a reward for the owner's work.
Always compare: with last year, with similar businesses, with targets. A ratio alone says little.
Show your working
Write the formula, substitute the figures, give the answer with units (% or times or days) to two decimal places unless told otherwise. Pearson's mark schemes accept responsible rounding, and the own figure rule means you can still earn comment marks using your own (wrong) ratio.
Worked example
Revenue £240,000, cost of sales £156,000, profit for the year £30,000 after loan interest of £2,000. Capital £144,000, bank loan £40,000. Calculate the four ratios.
- Gross margin = 35.00%.
- Mark-up = 53.85%.
- Profit for the year % = 12.50%.
- ROCE = 32,000 / 184,000 = 17.39%.
Answer: 35.00%, 53.85%, 12.50%, 17.39%.
Check yourself
- Revenue £180,000; cost of sales £117,000. Calculate the gross profit as a percentage of revenue.
Show answer
35.00 %. 63,000 / 180,000 x 100 = 35.00%.
- Using the same figures (revenue £180,000, cost of sales £117,000), calculate the percentage mark-up.
Show answer
53.85 %. 63,000 / 117,000 x 100 = 53.85%.
- Revenue £95,000; profit for the year £11,400. Calculate profit for the year as a percentage of revenue.
Show answer
12.00 %. 11,400 / 95,000 x 100 = 12.00%.
- Profit for the year £26,000 after loan interest of £3,000. Capital £120,000; long-term loan £30,000. Calculate ROCE.
Show answer
19.33 %. 29,000 / 150,000 x 100 = 19.33%.
- A business's gross margin has fallen but its revenue has risen. Which is the most likely explanation?
- Its rent has increased
- It has taken out a larger bank loan
- The owner's drawings have increased
- It has cut selling prices to increase sales volume
Show answer
It has cut selling prices to increase sales volume. Lower prices reduce gross profit per pound of sales but can increase volume.
- Gross margin is unchanged at 35% but profit for the year as a percentage of revenue has fallen from 14% to 10%. What does this suggest?
- Selling prices have fallen
- Expenses have risen relative to revenue
- Purchase prices have risen
- Closing inventory has been overvalued
Show answer
Expenses have risen relative to revenue. The fall happens below gross profit, so it is caused by expenses.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.