Solved Question: A firm’s gross profit margin has stayed constant from 2016 to 2017

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Question:

A firm’s gross profit margin has stayed constant from 2016 to 2017 but its net profit margin has declined over the same period. What does this tell you about how the firm’s COGS, its expenses, and its taxes have changed over 2016 to 2017?

$Gross Profit Margin =\frac{Gross Profit}{Revenue}$

$Net Profit Margin =\frac{Net Income}{Revenue}$

Gross Profit = Revenue – COGS

Net Income = Revenue – COGS – Expenses – Taxes

Between 2016 and 2017, if the Gross Profit Margin (GPM) remains the same, then there can be 2 cases:

a) Revenue and COGS are same in both years.

b) Rate of increase/decrease in revenue is the same as rate of increase/decrease in COGS.

But for the sake of simplicity let us assume that case (a) is TRUE.

Net Profit Margin (NPM) declines in the given time frame.

Net Income = Revenue – COGS – Expenses – Taxes

Since Revenue and COGS are unchanged, there must be an increase in expenses and Tax expenditure in 2017 compared to 2016.

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