Q.Distinguish between Gross Profit Ratio and Net Profit Ratio, and briefly explain the significance of Return on Capital Employed.

Gross Profit Ratio and Net Profit Ratio both measure profit as a percentage of sales, but they stop at very different points on the income statement.

Gross Profit Ratio measures the margin after deducting only the direct cost of goods sold, while Net Profit Ratio measures the final margin after all operating expenses, interest, and tax - a more complete profitability measure and always smaller. Return on Capital Employed, unlike either sales-based ratio, measures the return earned on all long-term funds (owners' pl …

Gross Profit Ratio vs Net Profit Ratio

Because the Net Profit Ratio deducts far more than the Gross Profit Ratio, it is always numerically smaller (30% versus 13.5% here) and gives a more complete picture of overall profitability, while the Gross Profit Ratio isolates how well the firm manages its direct trading/production costs alone.

Significance of Return on Capital Employed (ROCE)

Unlike the two sales-based ratios above, ROCE measures profit as a percentage of the total long-term capital invested (Shareholders' Funds + Long-term Debt), using profit before interest and tax. Its significance:

1. It shows how efficiently the firm's entire long-term capital is being used to generate returns, regardless of how much revenue that capital happens to generate.
2. It allows comparison between firms of different sizes and financing structures, since it measures return relative to the capital base rather than to sales. …

Students sometimes assume a firm with a higher Net Profit Ratio must automatically earn a higher ROCE - this need not hold, since ROCE also depends on how much capital was needed to earn that profit; a thinner margin on a much smalle …