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The table below shows two profitability ratios calculated for LEXO Ltd for the past two years: multicolumn(1)(|c|)( Ratio ) & 2022 & 2021 Gross profit margin & 35 % & 35 % Operating profit margin & 5 % & 15 % Which of the following statements is an incorrect interpretation of these ratios: The company had a very weak performance in 2022 compared to the vear before. The decline in the operating profit margin in 2022 can be wholly explained by a decline in the company's sales for that year. The ratios sugest the company's overheads and other expenses might have risen in 2022 compared to the year before.

Question

The table below shows two profitability ratios calculated for LEXO Ltd for the past two years:

 multicolumn(1)(|c|)( Ratio ) & 2022 & 2021 
 
Gross profit 
margin
 & 35 % & 35 % 
 
Operating 
profit margin
 & 5 % & 15 % 


Which of the following statements is an incorrect interpretation of these ratios:
The company had a very weak performance in 2022 compared to the vear before.
The decline in the operating profit margin in 2022 can be wholly explained by a decline in the company's sales for that year.
The ratios sugest the company's overheads and other expenses might have risen in 2022 compared to the year before.

The table below shows two profitability ratios calculated for LEXO Ltd for the past two years: multicolumn(1)(|c|)( Ratio ) & 2022 & 2021 Gross profit margin & 35 % & 35 % Operating profit margin & 5 % & 15 % Which of the following statements is an incorrect interpretation of these ratios: The company had a very weak performance in 2022 compared to the vear before. The decline in the operating profit margin in 2022 can be wholly explained by a decline in the company's sales for that year. The ratios sugest the company's overheads and other expenses might have risen in 2022 compared to the year before.

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AdamElite · Tutor for 8 years

Answer

The incorrect interpretation among the statements is 'The decline in the operating profit margin in 2022 can be wholly explained by a decline in the company's sales for that year'.

Explain

## Step 1: <br />Let's evaluate each of the given statements referring to the ratios provided for LEXO Ltd and check which is incorrect interpretation.<br /><br />## Step 2:<br />Analyzing the first statement — 'The company had a very weak performance in 2022 compared to the year before', the Gross profit margin for both the years is constant at 35%. Still, the Operating profit margin shows a reduction from 15% in 2021 to 5% in 2022 indicating lower performance in 2022 relative to the preceding year. The company's performance concerning profitability has declined. Therefore, this statement is accurate and true.<br /><br />## Step 3:<br />The next statement — 'The decline in the operating profit margin in 2022 can be wholly explained by a decline in the company's sales for that year', from the given data, it can be seen that the gross profit margin remained the same, meaning the gross profit or sales ratio in both years was identical and unchanged. The deteriorating operating profit margin cannot, in this scenario, be explained by a drop in sales since it remained the same. Therefore, this statement is incorrect.<br /><br />## Step 4:<br />Next, 'The ratios suggest the company's overheads and other expenses might have risen in 2022 compared to the year before', indeed, may explain the reduction in operating profit margin from 2021 to 2022. The Gross profit margin is stable, indicating a steady ratio of direct costs, while the operating profit margin decreases, which might imply an increase in overheads and other indirect operating expenses. Hence this is also a possibly correct interpretation.<br /><br />## Step 5:<br />And finally, looking into 'For every £1 of sales revenue, an average of 35p was left to cover other operating expenses in both years', is true as the gross profit margin in both years is 35%. This calculation implies that out of £1, the company could use 35p to cover additional categories of expenditures like selling, administrative, and financial expenses, etc., after adjusting direct production costs (Cost of goods sold or COGS). The statement by its literal stand is accurate.
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