A ratio comparison is fair when you name the two figures, say why they differ, and state one limit. The answer “A is better” is incomplete without the reason.
This lesson follows interpreting efficiency ratios.
Worked example: two fictional shops
An original pair for one year, in RM.
| Alia’s clothes shop | Budi’s electrical shop | |
|---|---|---|
| Sales | 100 000 | 400 000 |
| Gross profit | 45 000 | 72 000 |
| Net profit | 12 000 | 28 000 |
| Gross profit margin | 45% | 18% |
| Net profit margin | 12% | 7% |
| Stock turnover | 3 times | 12 times |
Alia’s margins are higher. Budi’s net profit is RM28 000, more than twice Alia’s RM12 000.
A model comment. Alia earns a higher net profit margin (12% against 7%), but Budi earns a larger profit (RM28 000 against RM12 000) because his sales are four times larger and his stock turns over 12 times a year against 3. Electrical goods usually carry a thinner margin, so a lower margin is expected. One year of data cannot show a trend.
What context should you check?
- Type of business. Shops that sell different goods expect different margins.
- Size. A larger turnover can make a small margin worth more ringgit.
- Period. Compare the same period, and look at earlier years if you have them.
- Policies. Different stock valuation or depreciation choices change profit.
The mistake that costs marks
The slip is to pick the higher margin and stop, or to conclude that the business with more profit is run better without looking at its size.
| Step | Wrong | Right |
|---|---|---|
| Conclusion | Alia is better because 12% > 7% | Each leads in a different measure |
| Reason given | None | Volume and stock turnover differ |
| Limit named | None | One year, different goods |
Examiners reward the reason and the limit as much as the ratio.
Check yourself
Business X has a net profit margin of 25% and business Y has 10%. A student writes “X is better”. Improve the comment, using at least two points to check.
Answer
A fuller comment: “X earns a higher net profit margin (25% against 10%), which suggests X keeps more profit from each ringgit of sales. Before calling X better, we need to know what each business sells, how large each is and whether the year was typical. Y may sell in higher volume, and one year shows no trend.”
Points checked: the ratio figures, the likely reason, business type, size and period.
What to study next
Test all four skills in the financial statement analysis practice set. Log weak comments in the mistake log.
If you want a teacher to work on your comment sentences, see online one-to-one Accounting tuition.