## Profitability Ratios

Ratios

**Profitability Ratios**

Profitablity Ratios measure how well businesses use their existing assets to generate profit and value for owners. Without Profits You Can't Survive !

**Profitability Ratios**

Profitability ratios measure and evaluate the ability of a business to generate income (profit) relative to revenue, balance sheet assets, and equity during a specific period of time. They show how well a company utilizes its assets to produce profit for the owners. These ratios should normally be calculated when financial statements are prepared - monthly, quarterly, and annually.

**Return on Total Assets**

- What It Tells Us:
**Return on Total Assets**measures the amount of net income generated for each dollar invested in total assets during a period by comparing net income to the average total assets. In other words, the return on assets ratio measures how well a company is managing its assets to produce profits during a period.

- Calculation: Divide Net Income for a Period by Average Total Assets for a Period Multiplied by 100
- Formula: Return on Total Assets = (Net Income / Average Total Assets) x 100

Multiplying by 100 converts the decimal to a percent

- How Normally Expressed: Percentage of Total Assets
- Bad or Good: The larger the percentage the better. You should use your financial information to spot trends and compare to industry averages if available.

- Additional Clarification: A ratio of 20% (.20) means that you have $0.20 of net income for every $1.00 of assets.

Example:

Return On Total Assets | |||

Information: Dollars in thousands | Month | Quarter | Year |

Beginning Period Total Assets | 200 | 200 | 200 |

Ending Period Total Assets | 210 | 225 | 300 |

Average Total Assets | 205 | 212.5 | 250 |

Net Income For Period | 15 | 50 | 175 |

Return On Total Assets | 7.32% | 23.53% | 70% |

Net Income / Average Total Assets x 100 |

**Return on Fixed Assets**

- What It Tells Us:
**Return on Fixed Assets**measures a companies return on their investment in property, plant, and equipment by comparing net sales with fixed assets. In other words, it calculates how well a company is a producing sales with its machininery and equipment**.** - Calculation: Divide Net Sales for a Period divided by Average Net Fixed Assets for a Period Multiplied by 100
- Formula: Return on Fixed Assets = (Net Sales / Average Net Fixed Assets) x 100

Multiplying by 100 converts the decimal to a percent

- How Normally Expressed: Percentage of Fixed Assets
- Bad or Good: The larger the percentage the better. You should use your financial information to spot trends and compare to industry averages if available.

- Additional Clarification: A ratio of 100% (1.00) means that you have $1.00 of net income for every $1.00 of fixed assets.

Example:

Return On Fixed Assets | |||

Information: Dollars in thousands | Month | Quarter | Year |

Beginning Period Total Fixed Assets | 20 | 20 | 20 |

Ending Period Total Fixed Assets | 21 | 22.5 | 30 |

Average Total Fixed Assets | 20.5 | 21.25 | 25 |

Net Income For Period | 15 | 50 | 175 |

Return On Fixed Assets | 73.17% | 235.29% | 700.00% |

Net Income / Average Total Fixed Assets x 100 |

**Return on Equity**

- What It Tells Us:
**Return on Equity**measures the net income generated for each dollar invested by the owner by comparing net income with average owner's equity. In other words, how well the company is managing the money invested by its owners to generate profits. - Calculation: Divide Net Income for a Period divided by Average Owner's Equity for a Period Multiplied by 100
- Formula: Return on Equity = (Net Income / Average Owner's Equity) x 100

Multiplying by 100 converts the decimal to a percent

- How Normaly Expressed: Percentage of Owner's Equity
- Bad or Good: The larger the percentage the better. You should use your financial information to spot trends and compare to industry averages if available.

- Additional Clarification: A ratio of 20% (.20) means that you have $0.20 of net income for every $1.00 of owner's equity.

Example:

Return On Average Owner's Equity | |||

Information: Dollars in thousands | Month | Quarter | Year |

Beginning Period Owner's Equity | 500 | 500 | 500 |

Ending Period Owner's Equity | 515 | 550 | 675 |

Average Owner's Equity | 507.5 | 525 | 587.5 |

Net Income For Period | 15 | 50 | 175 |

Return On Average Owner's Equity | 2.96% | 9.52% | 29.79% |

Net Income / Average Owner's Equity x 100 |

**Gross Profit Percentage (Margin)**

- What It Tells Us:
**Gross Profit Percentage**measures the percentage of sales dollars left after subtracting the cost of goods sold. - Calculation: Subtract Cost Of Goods Sold from Net Sales and Divide by Net Sales and Multiply by 100
- Formula: Gross Profit Percentage = (Net Sales - Cost Of Goods Sold) / Net Sales x 100

Multiplying by 100 converts the decimal to a percent

- How Normally Expressed: Percentage of Net Sales
- Additional Clarification: A ratio of 50% (.50) means that you have $0.50 of gross profit for every $1.00 of sales.

Example:

Gross Profit Percentage | |||

Information: Dollars in thousands | Month | Quarter | Year |

Net Sales For Period | 60 | 200 | 700 |

Cost Of Goods Sold For Period | 42 | 130 | 469 |

Gross Profit | 18 | 70 | 231 |

Gross Profit Percentage | 30% | 35% | 33% |

Gross Profit / Net Sales |

**Gross Profit By Products**

Gross Profit Percentage By Product For Quarter | ||||

Information: Dollars in thousands | Product A | Product B | Product C | Total |

Net Sales For Period | 60 | 75 | 65 | 200 |

Cost Of Goods Sold For Period | 45 | 52 | 33 | 130 |

Gross Profit | 15 | 23 | 32 | 70 |

Gross Profit Percentage | 25% | 30.7% | 49.2% | 35% |

Gross Profit / Net Sales |

Which product was our most profitable ? I hope you said Product C.

**Return on Sales (Net Profit Margin)**

- What It Tells Us:
**Return on Sales**measures how much net income or profit is generated as a percentage of sales. In other words, how many cents of profit the business has generated for each dollar of sale. - Calculation: Divide Net Income by Net Sales and Multiply by 100
- Formula: Return on Sales = (Net Income / Net Sales) x 100

Multiplying by 100 converts the decimal to a percent

- How Normally Expressed: Percentage of Net Sales
- Bad or Good: The larger the percentage the bette,r as larger profit margins mean that more of every sales dollar ends up as a profit. You should use your financial information to spot trends and compare to industry averages if available.

- Additional Clarification: A ratio of 10% (.10) means that you have $0.10 of net income for every $1.00 of sales.

Example:

Return On Sales | |||

Information: Dollars in thousands | Month | Quarter | Year |

Net Sales For Period | 60 | 200 | 700 |

Net Income For Period | 8.5 | 27 | 99 |

Return On Sales | 14.2% | 13.5% | 14.1% |

Net Income / Net Sales x 100 |

**Bad or Good**? The larger the percentage the better. You should use your financial information to spot trends and compare to industry averages if available to answer this question.

On to

**Liquidity Ratios**