Study Unit 2.1: Profitability Flashcards
Gross Profit Margin
Net Sales - Cost of Goods sold
- % of gross revenue that remains with the firm after paying for merchandise
- Key analysis is whether it remains stable with any change in sales
Gross Profit Margin Ratio
(Net Sales - Cost of Goods Sold)/ Net Sales
Operating Profit Margin Ratio
Operating Income / Net Sales
or EBIT/ Net Sales
Net profit margin
percentage that remains after other gains and losses (including interest expense) and income taxes have been added or deducted.
Net profit margin Ratio
Net Income / Net Sales
Operating Profit Margin
% that remains after selling and general and administrative expenses have been paid
Earnings before interest, taxes, depreciation, and amortization (EBITDA)
EBITDA is arrived at by adding back the two major noncash expenses to EBIT.
EBITDA is a controversial measure that is only used for companies that look bad under other ratios. Basically, it shows how a company is performing if fixed costs are ignored.
EBITDA Margin
EBITDA / Net Sales
Return on assets (ROA)
also called return on total assets, or ROTA
straightforward measure of how well management is deploying the firm’s assets in the pursuit of a profit.
Net Income / Average total assets
Return on equity (ROE)
measures the return per owner dollar invested.
Net Income / Average total equity
Relationship between ROA & ROE
ROA = ROE × (1 – Debt ratio)
sustainable growth rate
ROE × (1 – Dividend payout ratio)
- This ratio measures the potential growth of a firm without borrowing additional funds.
- The retention ratio, or the difference of 1 and the dividend payout ratio, is the portion of the income kept to grow the firm.
The difference in the two denominators is total liabilities. ROE will therefore always be greater than ROA.
DuPont Model – ROA
Net Income/Average total sales X Net Income/Net Sales X Net Sales/ Average total Assets or Net Profit Margin X total asset turnover
breakdown emphasizes that shareholder return may be explained in terms of both profit margin and the efficiency of asset management.
Total asset turnover
measures the level of capital investment relative to sales volume
if net sales increase and all other factors remain the same, the asset turnover ratio improves because more sales are being produced by the same amount of assets.
The DuPont Model – ROE
Net Income / Net Sales X
Net Sales / Average Total Assets X
Average Total Assets / Average Total Equity
Net Profit Margin X Asset Turnover X Equity Multiplier
