Cash Flow
Profitability Ratios: How Profitable is the Company?
Net sales/Net profit after taxes
The information necessary to determine a company’s profit as a percentage of sales can be found in the company’s income statement.
1. Magnetronics’ profit as a percentage of sales for 1999 was $1,307 divided by $48,769, or 2.68%.
2. This represented a decrease from 3.6% in 1995.
3. The deterioration in profitability resulted from a decrease in cost of goods sold as a percentage of sales, and from a decrease in operating expenses as a percentage of sales. The only favorable factor was the decrease in the income tax paid.
Management and investors are often more interested in the return earned on the funds invested than in the level of profits as a percentage of sales. Companies operating in businesses requiring very little investment in assets often have low profit margins but earn very attractive returns on invested funds. Conversely, there are numerous examples of companies in very capital-intensive businesses that earn miserably low returns on invested funds, despite seemingly attractive profit margins.
Therefore, it is useful to examine the return earned on the funds provided by the shareholders and by the “investors” in the company’s interest-bearing debt. To increase the comparability across companies, it is useful to use EBIAT (earnings before interest but after taxes) as the measure of return. The use of EBIAT as the measure of return also allows the analyst to compare the return on invested capital (calculated before the deduction of interest expense), with the company’s estimated cost of capital to determine the long-term adequacy of the company’s profitability.
4. Magnetronics had a total of $15,249 of capital at year-end 1999 and earned before interest but after taxes (EBIAT) $1,824 during 1999. Its return on invested capital is calculated as follows:
Earnings before interest but after taxes (EBIAT)/Owners' equity plus interest -
Net sales/Net profit after taxes
The information necessary to determine a company’s profit as a percentage of sales can be found in the company’s income statement.
1. Magnetronics’ profit as a percentage of sales for 1999 was $1,307 divided by $48,769, or 2.68%.
2. This represented a decrease from 3.6% in 1995.
3. The deterioration in profitability resulted from a decrease in cost of goods sold as a percentage of sales, and from a decrease in operating expenses as a percentage of sales. The only favorable factor was the decrease in the income tax paid.
Management and investors are often more interested in the return earned on the funds invested than in the level of profits as a percentage of sales. Companies operating in businesses requiring very little investment in assets often have low profit margins but earn very attractive returns on invested funds. Conversely, there are numerous examples of companies in very capital-intensive businesses that earn miserably low returns on invested funds, despite seemingly attractive profit margins.
Therefore, it is useful to examine the return earned on the funds provided by the shareholders and by the “investors” in the company’s interest-bearing debt. To increase the comparability across companies, it is useful to use EBIAT (earnings before interest but after taxes) as the measure of return. The use of EBIAT as the measure of return also allows the analyst to compare the return on invested capital (calculated before the deduction of interest expense), with the company’s estimated cost of capital to determine the long-term adequacy of the company’s profitability.
4. Magnetronics had a total of $15,249 of capital at year-end 1999 and earned before interest but after taxes (EBIAT) $1,824 during 1999. Its return on invested capital is calculated as follows:
Earnings before interest but after taxes (EBIAT)/Owners' equity plus interest -