Analysing The Income Statement

Question 1

Return on equity?

Answer 1

The return on equity measures how profitable a business is for its owner.

Put simply, for every dollar of investment, this ratio provides a percentage return which can be compared against other investments.

As a guide, the ratio should be between 10% and 12% for a business providing a good return on equity.

Question 2

Return on total assets

Answer 2

This ratio measures the amount of profit for every dollar of assets.

The result will vary considerably between industries.

Overall, the higher the ratio result the better.

Question 3

Profit margin

Answer 3

The profit margin is also known as the net profit ratio.

It measures the percentage of income that remains after all expenses have been paid.

This income can be distributed to the owners or reinvested back into the business.

The higher, the result, the more profitable the business is.

A result of 10% or more is considered very good.

Small businesses in Australia could average around 15%.

The profit margin is very good for comparing different size businesses in the same industry.

Question 4

Expense ratio

Answer 4

The expense ratio measures the efficiency of the business in generating profit.

Question 5

Gross profit margin

Answer 5

The gross profit margin shows the
proportion of profit generated from every dollar of sales before distribution, administration and financial expenses are paid.

It is the profit made from selling its goods and providing its services.

There is no general benchmark as the cost of sales will vary, widely between industries and between firms.

These results are best analyse against past results, industry averages, budgeted figures and like businesses results.