2.3 Profitability Ratios
By differentiate the income statement accounts and categories to show a company’s ability to generate profits from its operations. Profitability ratios focused on a company’s return on investment in inventory and other assets fundamentally, these ratios show how well companies can achieve profits from their operations. Investors and creditors can use profitability ratios to judge a company’s return on investment in inventory and other assets. These ratios basically show how well companies can achieve profits from their operations. There were five elements under the profitability ratios.
a) Gross Profits Margin
It is a profitability ratio that compares the gross margin of a business to the net sales. This ratio …show more content…
The amounts disclose the amount of gain that a business can extract from its total sales. The net sales part of the equation is gross sales minus all sales deductions, such as sales allowances. The net profit margin is aim to be a measure of the overall success of a business. A high net profit margin points that a business is determining its products correctly and is exercising good cost control. It is practicable for comparing the results of businesses within the same industry, since they are all subject to the same business environment and customer base, and may have approximately the same cost …show more content…
Above and beyond, the return on equity ratio proves how much profit each ringgit of common stockholders' equity creates. ROE is also a sign of how much helpful management is at using equity financing to fund operations and grow the company.
For the analysis, return on equity appraises how efficiently a firm can use the money from shareholders to generate profits and grow the company. Unlike other return on investment ratios, ROE is a profitability ratio from the investor's point of view which is not the company. More to the point, this ratio reckon how much money is produced based on the investors' investment in the company, not the company's investment in assets or something else. Higher ratios are almost always better than lower ratios, but have to be compared to other companies' ratios in the
Profitability ratios determine the companies' earnings. The Net Profit Margin is calculated by dividing net income by sales. Home Depot's portion of revenue from profits equaled 7.2% in 2005 and 6.3% in 2006. Lowe's portion of revenue from profits equaled 6.4% in 2005 and 6.6% in 2006. Home Depot had a decreased in profit margin while Lowe's increased its profit margin in 2006.
It is a profitability ratio and it calculates the ability of the company to produce profit from the investments of its shareholders. It shows the profit generated by each dollar of shareholder’s equity. It is important ratio because investors always see that how efficiently and effectively the management of the company is using their wealth to generate profit.
The gross profit margin ratio is used to show how much of each sales dollar is left after certain costs are covered (footnote). Looking at the table, Supervalu has increased its gross profit margin from 14.4% in 2015 to 14.7% in 2016 (in millions of dollars). This shows that net income for 2015 was 14.4 percent of sales and in 2016 increased to 14.7 percent of sales. Likewise, Walmart has increased its gross profit margin from 24.8% in 2014 to 25.1% in 2016 (in millions of dollars).
Return on equity (ROE) measures profitability from the stockholders perspective. The ROE is a calculation of the return earned on the common stockholders' investment in the firm. Generally, the higher this return, the better off the stockholders are. Harley Davidson's return on equity was 24.92% for 2001, 24.74% for 2000. They have sustained consistent, positive, returns for their shareholders for the past two years.
Profitability ratios express ability of the company to produce profit. This shows how well a company is performing in a given period of time. To compare the profitability for the companies, the investors use profitability ratios that are return on equity, profit margin, asset turnover, gross profit, earning per share. Return on asset indicates overall profitability of assets. It is the relationship between net income and average total assets. GM has 0.034 and Ford has 0.036. This indicates Ford is more profitable. Profit margin is how much of every dollar of sales the company keeps. Computing profit margin, net income divided by net sales. This indicates higher profit margin is more profitable and it has better control. Thus, GM’s profit margin is 3.4 percentages and Ford’s is 4.9 percentages. This indicates Ford has better control profitably compared to GM. Next ratio is gross profit rate. It is how much of every dollar is left over after paying costs of goods sold. Assets turnover represents how efficiency a company uses its assets to sales. This ratio is relationship between net sales and average total assets. GM’s is 0.98 and Ford’s is 0.75. This result represents GM is using its assets more efficiently. Gross profit margin is dividing gross profit, which is equal to net sales less cost of gods sold, by net sales. This ratio indicates ability to maintain selling price above its cost of goods sold. GM’s gross profit rate is 11.6 percentages. Ford’s is 5.7 percentages. GM is higher ratio, and it indicates strong net income. Also, it indicates the company has to spend lower operating expenses and the company is able to spend left money for covering fixed costs. Earnings per share indicate the company’s net earnings to each share common stock. This ratio shows margin between selling price and cost of goods sold. From these companies’ income statement, GM is $2.71 and Ford is $1.82. Because GM’s value is higher relative to Ford’s,
Return on Equity (ROE) is defined as net profit/Total equity. This ratio shows how much company earned on the money of shareholders. In 2012, ROE is deeply negative at 44.4% but in 2013, it got significantly improved and touched 6.5%. However, it can’t be treated as a healthy figure but in comparison to profit margin or operating ratio, it is a respectable one.
Description: Return on Equity (ROE) indicates what each owner’s dollar is producing in terms of net income that is the rate of return on stockholder dollars. ROE is a common metric for assessing the value of a firm and most investors look to ROE first when deciding where to allocate their capital. As such, it is also an important measure for a CEO to monitor.
Ratios for return on assets and return on equity offer support for the loss in stockholders’ equity. Return on assets went from 13.1 in 2000 to 5.1 in 2001 and return on equity dropped from 25.4 in 2000 to 8.7 in 2001. Return on equity represents return on assets divided by the difference of 1 and debts/assets.
Ratio Analysis is a very powerful analytical tool used for measuring performance of an organisation to show the financial healthiness of such organisation. Accounting ratio may just be used as a symptom by analysts just like blood pressure, body temperature, pulse rate etc. The physician analyses this information to know the causes of the illness. Similarly, the financial analysis should also analyse the accounting ratios to diagnose the financial health of an enterprise. Generally, we can break down Ratio Analysis into four steps:
Gross profit ratio is a profitability ratio that shows the relationship between gross profit and total net sales revenue. The ratio is computed by dividing the gross profit figure by net sales. The basic components of the formula of gross profit ratio are gross profit and net sales. Gross profit is equal to net sales minus cost of goods sold. Net sales are equal to total gross sales less returns inwards and discount allowed. The information about gross profit and net sales is normally available from income statement of the company. The ratio can be used to test the business condition by comparing it with past years’ ratio and with the ratio of other companies in the industry. A consistent improvement in gross profit ratio over the past years is the indication of continuous improvement. When the ratio is compared with that of others in the industry, the analyst must see whether they use the same accounting systems and practices.
DuPont equation provides a broader picture of the return the company is earning on its equity. It tells where a company 's strength lies and where there is a room for improvement DuPont analysis examines the return on equity (ROE) analysing profit margin, total asset turnover, and financial leverage. DuPont analysis decomposing ROE into its components allows analyst to identify adverse impact on ROE and predict the future trends. Return on equity (ROE) measure the rate of return flowing to shareholder. The higher the ROE the, the better it is. It concludes that a company can earn a high return on equity if it earns a high net profit margin, it uses its assets effectively to generate more sales; and/or it has a high financial leverage.
The analysis of these ratios shows how Ford stands as a company for the past five years. Return on equity (ROE) reveals how much profit a company earned in comparison to the total amount of shareholder equity on the balance sheet. For long-term investing with great rewards, companies that have high return on equity ratios can provide the biggest payoffs. This ratio also tells investors how effectively their capital is being reinvested, so it is a good gauge of management's money handling skills. Ford is showing a considerable turn around in this area this past year, which could easily be due to changes in management. They are also reasonably following the industry in this area.
The Net Profit Margin compares the net income and net sales of a company. The Net Profit Margin is expressed as a percentage. Net Profit Margin is used to analyse the financial performance of a company. The NPM is important for creditor and investor to make a correct judgement. Creditors and investors use this ratio to determine how well a company controls its costs. The higher the NPM, the more effective the company is in converting revenues into profits. Creditors need to ensure the company has enough profits to pay back the loans while investors need to ensure the company’s profits are enough for distributing dividends. Besides that, the NPM also can be used as a clue to the company in pricing policies, production efficiency and cost