7.9 Profitability ratios Flashcards
What is the purpose of profitability ratios?
To measure the capability of the company to generate profit compared to expenses, sales, assets and shareholder equity.
What is profitability a measure of?
The company’s effectiveness in capital and asset utilization.
What are the two categories of profitability ratio?
Margin ratios
Return ratios
What are margin ratios?
A measure of the company’s ability to convert sales into profits, e.g.:
- gross profit margin ratio
- operating margin ratio
- net profit margin ratio
What are return ratios?
A measure of the company’s ability to generate returns to its shareholders, e.g.:
- return on assets ratio
- return on capital employed (ROCE)
- return on equity (ROE)
What does gross profit margin ratio calculate?
The ratio of gross profit to sales (i.e. how much the company is earning given its costs to produce its goods/services)
What is the formula for calculating gross profit margin ratio?
(gross profit / sales) x 100
What does operating profit margin ratio calculate?
The ratio of operating margin to sales (i.e. the percentage of sales remaining after accounting for operating expenses).
What is the formula for calculating profit margin ratio?
(Operating / sales) x 100
What does net profit margin ratio calculate?
The company’s ability to earn profit after taxes.
What is the formula for calculating net profit margin ratio?
(Net profit / sales) x 100
What does return on assets ratio calculate?
How effectively assets are used in comparison to the income earned.
What is the formula for calculating return on assets ratio?
Net income / total assets
What does return on equity ratio calculate?
The company’s ability to provide returns to its equity holders.
What is the formula for calculating return on equity ratio?
Net income / total equity.
