profitability ratios

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Profitability ratios
There are three main ratios that can be used to measure the profitability of a business:
1. The gross profit margin.
2. The net profit margin.
3. Return on Capital Employed (R.O.C.E).
The gross profit margin
This measures the gross profit of the business as a proportion of the sales revenue. It is calculated
using the following formula:
For example, if a business has gross profit of £4 million and sales revenue of £6 million, then the
gross profit margin would be:
This means that for every £1 of sales revenue, £0.67 remains after all direct expenses have been
deducted. This money then contributes towards covering the other expenses of the business.
The business would want this margin to be as high as possible, since a high margin will leave more
profit for covering the remaining expenses and, if the business is a 'company', for covering the
dividend payments to shareholders.
The net profit margin
This measures the net profit of the business as a proportion of the sales revenue. It is calculated
using the following formula:
For example, if a business has gross profit of £1 million and sales revenue of £6 million, then the
net profit margin would be:
This means that for every £1 of sales revenue, 16.7 pence remains after all direct and indirect
expenses have been deducted. This money then contributes towards covering the corporation tax

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Inland Revenue and, if the business is a 'company', covering the
dividend payments to shareholders.
Any profit which remains is kept in the business for reinvestment and is called 'retained profit'.
Again, the business would want this margin to be as high as possible, allowing both large dividend
payments to shareholders and a significant amount of profit to be retained for growth.
Return on Capital Employed (R.O.C.…read more

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