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IAI Actuarial Core Principles · Business Finance · Interpreting company accounting information

A company's gross profit margin has remained stable, but its net profit margin has fallen sharply over two years. Which is the most likely explanation?

The likely cause is that operating expenses or finance costs have grown faster than revenue. With gross margin stable, cost of sales and revenue moved together, so the erosion of net margin must come from costs below gross profit such as overheads, interest or tax.

  1. AOperating expenses or finance costs have grown faster than revenueCorrect
  2. BCost of sales has risen faster than revenue
  3. CSelling prices have been cut while unit costs stayed fixed
  4. DInventory turnover has improved
  5. Asset turnover has increased

Explanation

A stable gross margin means revenue and cost of sales moved proportionately, so the fall in net margin must arise below gross profit, from operating expenses, interest or tax. Options B and C would reduce gross margin, while D and E are efficiency measures that do not explain the fall.

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