08 profitability

Question 1

• Profitability is the metric used to determine the company’s profit in relation to the size of the business. It is a measurement of efficiency – and ultimately its success or failure.
• While profit is an absolute amount, profitability is a relative one.
• Profitability also indicates the return of an investment in comparison with an alternative investment.

Answer 1

• Although a company can make a profit, this does not necessarily mean that the company is profitable.
• Profitability ratios consist of a group of metrics that assess a company’s ability to generate profit relative to its revenue, operating costs, assets and equity.
• Higher ratio results are more favorable, but ratios provide much more information when compared to results from similar companies, the company’s own historical performance, or the industry average.

Question 2

• Based on Income Statement:

Ø Gross Profit Percentage

Ø Operating Profit Percentage

Ø Return on Sales (Net Income Percentage, Net Profit Margin)

• Measures % of Profit that the entity makes from merely selling a product, before other operating cost are subtracted.

Answer 2

• Measures % of Profit earned by €1 of Sales in the company’s core business operations.
• Persistently high operating income compared to net sales is an important determinant of earnings quality.

Question 3

• Shows the net income generated by net sales
• The higher the %, the more profit is being generated by €1 of sales.

Question 4

4. Total asset management

• Mixed Ratios:

Ø Return on Assets (ROA)

ü Asset Turnover

Ø Return on Equity (ROE)

Ø Dupont Analysis

ü Leverage Ratio

Ø Earnings Per Share

• Measures net sales generated for each euro invested in assets.
• How efficiently management is operating the company’s assets?
• Companies with high assets turnover tend to be more productive.

Answer 4

• Measures how profitable a company uses its assets.
• ROA is often computed on a divisional or product-line level, to identify less profitable segments

Question 5

• Shows relationship between net income and common stockholders’ investment in the company.
• How much income is earned for every €1 invested in the company

Answer 5

• Leverage Ratio or Equity Multiplier measures the proportion of each euro of assets financed with shareholders’ equity.
• The higher the leverage ratio, the more ROE increases.
• With high Net Income àROE is positive àHigh Leverage ratio increase ROE even more. The company is using debt to generate profit.

Question 6

• Leverage Ratio or Equity Multiplier measures the proportion of each euro of assets financed with shareholders’ equity.
• The higher the leverage ratio, the more ROE increases.
• With high Net Income –> ROE is positive -→ High Leverage ratio increase

ROE even more. The company is using debt to generate profit

Answer 6

Question 7

• Amount of net income earned for each share of outstanding common stock.

Answer 7