ACCA Applied Knowledge · Financial Accounting · Analysis of financial statements
A company's gross profit margin rose from 30% to 36% over the year, but its operating profit margin fell from 12% to 10%. Which of the following is the most likely explanation?
The most likely explanation is that operating expenses rose as a percentage of revenue. Gross margin improved, so cost of sales and pricing were not the problem, yet operating margin fell, meaning overheads such as distribution or administration costs grew faster than sales.
- ASelling prices were reduced during the year
- BOperating expenses increased as a proportion of revenueCorrect
- CThe cost of goods sold increased as a proportion of revenue
- DClosing inventory was overvalued at the year end
Explanation
Gross margin rose by 6 points while operating margin fell by 2 points, so expenses below gross profit must have risen by about 8 points of revenue. Lower selling prices or higher cost of sales would reduce gross margin, not raise it. Overvalued closing inventory would raise both gross and operating profit.
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