Profitability ratios Flashcards
What do profitability ratios measure?
How well are revenues converted into profits?
What are the two types of profitability ratio?
- Profit margin ratios
- Return ratios
What are the three main profit margin ratios?
- Gross profit margin
- Operating profit margin
- Net profit margin
What is the formula for gross profit margin?
gross profit / sales revenue x 100
What is the formula for operating profit margin?
operating profit / sales revenue x 100
What is the formula for net profit margin?
net profit / sales revenue x 100
What is the relationship between gross profit margin and cost of goods sold?
gross profit margin + CoGS as a % of revenue = 100%
What is the relationship between operating profit margin and operating expenses?
operating profit margin + OpEx as a % of revenue = gross profit margin
What can the relationship between different profit margins tell us?
Whether increased profit is driven by reduced CoGS or OpEx
What are the three main return ratios?
- Return on capital employed (ROCE)
- Return on equity (ROE)
- Return on assets (ROA)
What does ROCE stand for?
Return on capital employed
What does ROE stand for?
Return on equity
What does ROA stand for?
Return on assets
What is the formula for ROCE?
operating profit / capital employed x 100
What is the primary measure of profitability?
ROCE
What is the formula for ROE?
net profit / equity x 100
What is the most relevant ratio for shareholders?
ROE
What is the formula for ROA?
net profit / assets x 100
What is “capital employed”?
Long-term capital available for business activities
How is “capital employed” calculated?
equity + non-current liabilities OR
total assets - current liabilities
What is sometimes used in the ROCE formula in place of operating profit?
EBIT (earnings before interest and tax)
How is EBIT calculated?
net profit + interest expense + tax
What is the difference between operating profit and EBIT?
EBIT includes non-operating gains / losses e.g. interest, disposal of assets
When is ROA most useful?
When comparing firms with different capital structures (high equity vs high liabilities)
When is ROE most useful?
When analysing stable, established companies with high equity
