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ACCA Applied Knowledge · Financial Accounting · Importance and purpose of analysis of financial statements

Zeta Co's gross profit margin was 30% last year and is 25% this year. Which of the following is the most appropriate use of this information by an analyst?

The fall in gross margin should be treated as a prompt for investigation into causes such as lower prices, higher costs or a changed product mix. It does not prove inefficiency, and it does not show that revenue fell by 5%.

  1. AConclude that the company is definitely less efficient and should be avoided
  2. BTreat it as an indicator to investigate, for example selling price cuts, rising cost of sales or a change in product mixCorrect
  3. CIgnore it because only the statement of financial position is useful for analysis
  4. DConclude that revenue has fallen by 5%

Explanation

A change in a ratio is a signal for further investigation, not a conclusion. Possible causes include lower selling prices, higher input costs or a different sales mix. A fall in margin says nothing definite about revenue, which could have risen or fallen.

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