Profitability Ratios - BC Bookkeeping Tutorials|dwmbeancounter.com

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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
Our example ratios mean that for the month we had 7 cents, for the quarter we had 24 cents, and for the year we had 70 cents of net income for every \$1.00 of assets.
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
Our example ratios mean that for the month we had 74 cents, for the quarter we had \$2.35, and for the year we had \$7.00 of net income for every \$1.00 of fixed assets.
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
Our example ratios mean that for the month we had 3 cents, for the quarter we had 10 cents, and for the year we had 30 cents of net income for every \$1.00 of owner's equity .
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
• 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 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
Our example ratios mean that for the month we had 30 cents, for the quarter we had 35 cents, and for the year we had 33 cents of gross profit for every \$1.00 of 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
Our example ratios mean that for Product A we had 25 cents, for Product B we had 31 cents,  for Product C we had 49 cents, and for all the products combined we had 35 cents of gross profit for every \$1.00 of 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
Our example ratios mean that for the month we had 14 cents, for the quarter we had 14 cents, and for the year we had 14 cents of net income for every \$1.00 of sales .

Are our example ratios 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.

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