Scribd
Upload
28 views

Chapter 2 Part 3 - Ratio Analysis

Here are the key points to note from the ratios: - Gross, operating and net profit margins are higher than industry averages indicating better profitability. - Return on assets is slightly lower than industry average indicating assets could be utilized more efficiently. - Return on equity is higher than industry average indicating equity is being used effectively to generate profits. Overall, the firm is more profitable than its competitors based on higher margins. Asset utilization could be improved slightly but equity investment is generating above average returns. The ratios indicate generally strong financial performance compared to peers.

Uploaded by

Mohamed Hosny
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
28 views

Chapter 2 Part 3 - Ratio Analysis

Here are the key points to note from the ratios: - Gross, operating and net profit margins are higher than industry averages indicating better profitability. - Return on assets is slightly lower than industry average indicating assets could be utilized more efficiently. - Return on equity is higher than industry average indicating equity is being used effectively to generate profits. Overall, the firm is more profitable than its competitors based on higher margins. Asset utilization could be improved slightly but equity investment is generating above average returns. The ratios indicate generally strong financial performance compared to peers.

Uploaded by

Mohamed Hosny
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 13

Chapter 2 – Financial

statements and Ratio


Analysis
DR. DOAA AYMAN
Profitability Ratios

The Gross Profit Margin (GPM) measures the percentage of sales revenue remaining after
the firm has paid the cost of goods sold, and is calculated as:
  𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 ( 𝐆𝐏𝐌 ) =
𝐒𝐚𝐥𝐞𝐬
OR

  𝐒𝐚𝐥𝐞𝐬 − 𝐂𝐎𝐆𝐒
𝐆𝐏𝐌 =
𝐒𝐚𝐥𝐞𝐬
Profitability Ratios
• Gross profit the first level of profitability, tells analysts how good a
company is at creating a product or providing a service compared to
its competitors.
• The GPM affected by the price of the good, the cost of production
and the sales. If the cost of goods increases, or price has decreased, or
sales decreased the GPM will definitely decline.

The higher the GPM the better


Profitability Ratios
The Operating profit margin (OPM) measures the percentage of sales
revenue remaining after all costs and expenses other than interest, taxes,
and preferred stock dividends are deducted.
  𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭 (𝐄𝐁𝐈𝐓 )
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 ( 𝐎𝐏𝐌 ) =
𝐒𝐚𝐥𝐞𝐬

The higher the OPM the better


Profitability Ratios
The Net Profit Margin (NPM) measures the percentage of sales revenue
remaining after all costs and expenses including interest, taxes, and preferred
stock dividends are deducted and is calculated as follows:
 

NPM is a good measure of the firm’s success with respect to earnings on sales,
but it MUST be evaluated within the industry!
Profitability Ratios

The Earnings per share ratio (EPS ratio) measures the amount of a
company's net income that is theoretically available for payment to
the equity (common stock) holders and is calculated as:

 
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐀𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞𝐭𝐨𝐂𝐨𝐦𝐦𝐨𝐧𝐒𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
𝐄𝐏𝐒=
𝐍𝐮𝐦𝐛𝐞𝐫𝐨𝐟 𝐒𝐡𝐚𝐫𝐞𝐬𝐨𝐟 𝐂𝐨𝐦𝐦𝐨𝐧𝐒𝐭𝐨𝐜𝐤𝐎𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠
Profitability Ratios

• A higher EPS means that a company is profitable enough to pay out more


money to its shareholders. For example, a company might increase its dividend
as earnings increase over time.  
• Investors typically compare the EPS of two companies within the same industry
to get a sense of how the company is performing relative to its peers. 
• Establishing trends in EPS growth gives a better idea of how profitable a
company has been in the past and may be in the future. A company with a
steadily increasing EPS is considered to be a more reliable investment than one
whose EPS is on the decline or varies substantially.
Profitability Ratios
• The Return on Assets ratio (ROA) measures the overall effectiveness of
management in generating profits using its available assets and is
calculated as:

  𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐀𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐭𝐨 𝐂𝐨𝐦𝐦𝐨𝐧 𝐒𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬


(𝐑𝐎𝐀)=
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
Higher ROA indicates more asset efficiency and hence more net income generated
Profitability Ratios
Interpretation:
For each $1 invested in assets, the firm generates net income of $....

It only makes sense that a higher ratio is more favorable to investors


because it shows that the company is more effectively managing its
assets to produce greater amounts of net income
Profitability Ratios

• The Return on Equity ratio ROE measures the overall effectiveness of


management in generating profits using its common stockholders’ equity.

 
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐀𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐭𝐨𝐂𝐨𝐦𝐦𝐨𝐧 𝐒𝐭𝐨𝐜𝐤𝐡𝐨𝐥𝐝𝐞𝐫𝐬
(𝐑𝐎𝐄)=
𝐂𝐨𝐦𝐦𝐨𝐧 𝐒𝐭𝐨𝐜𝐤 𝐄𝐪𝐮𝐢𝐭𝐲
In other words, it measures the profitability of a corporation in
relation to stockholders’ equity.
Profitability Ratios

Interpretation:
For every dollar of common stockholders’ equity generates …$
dollar of net income
The higher the ROE, the more efficient a company's management is
at generating income and growth from its equity financing. 
This is an important measurement for potential investors because
they want to see how efficiently a company will use their money to
generate net income.
Solved
Example
Calculate the liquidity and activity ratios and then interpret each
ratio.
Note: the firm`s purchases represent 70% of the annual sales
Ratio Actual 2011 Actual 2012 Industry Average

Gross Profit margin 22% 25%

Operating profit margin 25% 29%

Net profit margin 20% 18.5%

Return on Assets 14% 15%

Return on Equity 12% 11%

You might also like