Financial Accounting · Ratios

Profitability Ratios: Gross Margin, Operating Margin and ROCE

Updated 11 October 2026 · Fact-checked

Profitability ratios show how well a business turns sales and capital into profit. Gross profit margin is gross profit ÷ revenue, operating profit margin is operating profit ÷ revenue, and ROCE is profit before interest and tax ÷ capital employed. Calculate each as a percentage, compare with another year, then explain the cause of the change.

Understand Profitability Ratios

A profitability ratio compares a profit figure with something else, usually revenue or the capital invested. A raw profit number tells you little. Profit of $200,000 is excellent on $1m of revenue and poor on $50m. A ratio lets you compare years, and compare one business with another.

The gross profit margin looks at the first layer of profit: revenue less cost of sales. It tells you how much of each $1 of sales is left after paying for the goods sold. The operating profit margin goes further. It deducts distribution costs and administrative expenses too, so it shows the profit from running the business before finance costs and tax.

Return on capital employed (ROCE) measures the profit earned on the long-term money in the business. Capital employed is usually total equity plus non-current liabilities. ROCE answers the question: for every $1 of long-term funding, how much operating profit did management generate?

The ratios are only useful if you can explain them. A fall in gross margin points to selling prices falling, or cost of sales rising faster than revenue. A fall in operating margin with a steady gross margin points to expenses rising. ROCE can fall because margins fall, or because capital grew without a matching rise in profit.

Do not confuse margin with mark-up. Margin is profit as a percentage of selling price. Mark-up is profit as a percentage of cost. Margin is always the smaller figure for the same profit.

Key formulas to remember

Gross profit margin: Gross profit ÷ Revenue × 100; Gross profit = revenue − cost of sales.
Operating profit margin: Operating profit ÷ Revenue × 100; Operating profit is profit before finance costs and income tax.
Return on capital employed (ROCE): Profit before interest and tax ÷ Capital employed × 100; Capital employed = total equity + non-current liabilities. Use the closing figures unless told otherwise.
Mark-up on cost: Gross profit ÷ Cost of sales × 100; Mark-up is based on cost, not selling price.
Margin and mark-up link: Margin = Mark-up ÷ (100% + Mark-up); Mark-up = Margin ÷ (100% − Margin); A 25% mark-up equals a 20% margin.
ROCE split: ROCE = Operating profit margin × Asset turnover; Asset turnover = Revenue ÷ Capital employed. It shows whether a ROCE change comes from margin or from use of capital.

How to solve Profitability Ratios questions

Use the same routine for any profitability question. It keeps your calculations clean and your explanation tied to the numbers.

1Read the question and note exactly which ratio is asked for and whether the answer is a percentage or a number of decimal places.
2Pick out the right figures: revenue, cost of sales, operating profit (or profit before interest and tax) and capital employed.
3Check that the profit figure matches the ratio. Use profit before finance costs and tax for operating margin and ROCE.
4Write the formula, substitute the figures and calculate.
5Round as the question instructs. If it does not, one decimal place is safe.
6If asked about a change, compare with the other year and state the direction and size.
7Give reasons that fit the data, such as lower selling prices, higher input costs, rising expenses or extra capital raised.
8Link ratios together. Say if the operating margin moved with the gross margin or differed from it.

Quickest way: Fast route for objective test questions

When to use it: Use this for number entry and multiple choice questions on the three ratios, when you have about two to three minutes per question.

Underline the ratio and the required rounding.
Find the two numbers only. Ignore everything else in the extract.
Divide, multiply by 100, then round.
For mark-up and margin questions, convert using a $100 cost or $100 sales example.
Check sense: margins should be below 100% and operating margin below gross margin.
For explanation questions, eliminate options that contradict the figures, such as a cost rise when cost of sales fell.

Common mistakes in Profitability Ratios

Using profit after interest and tax in ROCE.
Students take the final profit line in the statement.
Fix: Use operating profit, which is profit before finance costs and income tax.
Dividing by cost of sales when asked for gross margin.
Margin and mark-up look alike.
Fix: Margin always divides by revenue. Mark-up divides by cost of sales.
Counting current liabilities in capital employed.
Students use net assets or total liabilities by habit.
Fix: Use total equity plus non-current liabilities, unless the question defines it differently.
Converting a mark-up to a margin by simple subtraction or swapping.
Students assume 25% mark-up means 25% margin.
Fix: Use a $100 cost example. Cost $100, mark-up 25% gives sales $125 and margin 25 ÷ 125 = 20%.
Giving a vague reason such as 'the business did worse'.
Students describe the ratio instead of explaining it.
Fix: Name a specific cause and tie it to the figures, for example 'cost of sales rose faster than revenue'.
Forgetting the percentage sign or rounding wrongly in number entry.
Time pressure.
Fix: Re-read the answer box instruction and round only at the end.

Worked examples

Example 1

A company reports revenue of $800,000, cost of sales of $520,000, distribution costs of $64,000 and administrative expenses of $96,000. Finance costs were $20,000. Equity is $500,000 and non-current liabilities are $300,000. Calculate the gross profit margin, operating profit margin and ROCE to one decimal place.

Show the solution

Gross profit = 800,000 − 520,000 = $280,000.
Gross profit margin = 280,000 ÷ 800,000 × 100 = 35.0%.
Operating profit = 280,000 − 64,000 − 96,000 = $120,000. Finance costs are excluded.
Operating profit margin = 120,000 ÷ 800,000 × 100 = 15.0%.
Capital employed = 500,000 + 300,000 = $800,000.
ROCE = 120,000 ÷ 800,000 × 100 = 15.0%.

Answer: Gross profit margin 35.0%, operating profit margin 15.0%, ROCE 15.0%.

Example 2

Last year a company had revenue of $400,000 and gross profit of $120,000. This year revenue is $500,000 and gross profit is $125,000. Calculate the gross profit margin for both years and suggest two reasons for the change.

Show the solution

Last year: 120,000 ÷ 400,000 × 100 = 30.0%.
This year: 125,000 ÷ 500,000 × 100 = 25.0%.
Margin fell by 5 percentage points even though gross profit rose in dollars.
Revenue grew by 25% (100,000 ÷ 400,000) but gross profit grew by only about 4.2% (5,000 ÷ 120,000).
Cost of sales rose from $280,000 to $375,000, a much faster increase than revenue.
Possible reasons: selling prices were cut to win volume, or suppliers raised prices that were not passed on to customers.

Answer: Gross margin fell from 30.0% to 25.0%. Likely reasons are lower selling prices and higher purchase costs not passed on to customers.

Exam tips

Check which profit figure the question gives. Operating profit and profit before interest and tax are the same for ROCE in most FA questions.
In multiple response questions on reasons, pick only the causes that fit both the ratio and the figures given.
Practise margin and mark-up conversions. They appear often in objective tests, including incomplete records questions.
Do not round part-way through. Keep full figures until the final answer.
When two years are given, always compare. A single ratio rarely earns the explanation marks.

Practice questions from Ratios

Profitability Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Profitability Ratios: frequently asked questions

What is the formula for gross profit margin?

Gross profit margin = gross profit ÷ revenue × 100. Gross profit is revenue less cost of sales. The result shows the percentage of each sale left after paying for the goods sold.

How do I calculate ROCE in ACCA FA?

ROCE = profit before interest and tax ÷ capital employed × 100. Capital employed is normally total equity plus non-current liabilities. Read the question for any different definition.

What are the reasons for a fall in gross profit margin?

Common reasons are lower selling prices, higher purchase or production costs, a change in the sales mix towards lower-margin products, and inventory losses or write-downs. Check the figures to see which fits the data.

What is the difference between gross margin and mark-up?

Margin is gross profit as a percentage of revenue. Mark-up is gross profit as a percentage of cost of sales. For the same profit, margin is always lower than mark-up.