Profitability Ratios

Question 1

What is Gross profit margin?

Answer 1

Gross profit margin = Gross profit / Net sales

Gross profit margin is what percentage of gross revenues with the firm after paying for merchandise

The key analysis with respect to the gross profit margin is whether it is keeping up with the increase or decrease in sales

For example, a 10% increase in sales should be accompanied by at least a 10% increase in the gross profit margin

Question 2

What is Operating profit margin?

Answer 2

Operating profit margin = Operating income / Net sales

Operating profit margin is what percentage remains after selling and general and administrative expenses have been paid

Question 3

What is Net profit margin?

Answer 3

Net profit margin = Net income / Net sales

Net profit margin is what percentage remains after other gains and losses (including interest expense) and income taxes have been added or deducted

Question 4

What is Earnings before interest, taxes, depreciation and amortization (EBITDA)?

Answer 4

EBITDA is a commonly used performance measure that approximates accrual-basis profits from ongoing operations

EBITDA is arrived at by adding back the two major noncash expenses to EBIT

Question 5

What is EBITDA margin percentage?

Answer 5

EBITDA margin % = EBITDA / Net sales

Question 6

What is Return on assets (ROA)?

Answer 6

Return on assets (also called return on total assets or ROTA) is a straightforward measure of how well management is deploying the firm’s assets in the pursuit of a profit:

= Net Income / Average total assets

Question 7

What is Return on equity (ROE)?

Answer 7

Return on equity (ROE) measures the return per owner dollar invested:

= Net Income / Average total equity

Note: The difference in the denominator for this formula (as compared to ROA) is liabilities; thus ROE will therefore ALWAYS be greater than ROA