Profitability notes business
Profitability
Profitability is the relationship between profit and sales and helps managers to determine how well each dollar of sales generates profits
The level of profitability depends on:
1. The volume of sales
2. The percentage mark-tup applied
3. The level of expenses incurred
There are three ratios to measure profitability:
Gross Profit Ration (GPR)
Is derived from the income statement
It shows how well the company is maintaining and adequate margin between sales and purchases
The GPR calculates how much GP is made (for every $1 of sales) after COGS has been paid
For example:
A result of 70% means that for every $1 of sales revenue, $0.70 has been made in GP
In order to analyse:
The GP margin reflects the ‘mark up’ between the firm’s purchasing costs and its selling prices
A low or declining GP margin suggests high supply costs and/or products are priced too low
A high GP margin suggests low supply costs/and or products priced to high
Alternative suppliers may need to be sourced if supply costs are too high
Some authors feel that 40% for retail businesses is good
The higher the GPR the better
Net profit Ratio (NPR)
Is derived from the Income Statement
It shows the amount of sales revenue that results in net profit. Businesses should aim for a high net profit ratio.
The NPR calculates how much NP is made (for every $1 of sales) after expenses have been paid.
For example
A result of 25% means that for every $1 of sales revenue, $0.25 has been made in NP.
In order to analyse:
The NP margin reflects the expenses of a business.
A low or declining NP margin (especially when the GP is relatively high) suggests excessive costs.
A high NP margin suggests low costs/expenses and sound financial management.
A low or declining NP margin suggests that expenses should be examined to see whether reductions can be made (e.g. staffing costs)
Some authors feel a 10-12% NPR is ‘good’
The higher the NPR the better
Return on Owners
Profitability is the relationship between profit and sales and helps managers to determine how well each dollar of sales generates profits
The level of profitability depends on:
1. The volume of sales
2. The percentage mark-tup applied
3. The level of expenses incurred
There are three ratios to measure profitability:
Gross Profit Ration (GPR)
Is derived from the income statement
It shows how well the company is maintaining and adequate margin between sales and purchases
The GPR calculates how much GP is made (for every $1 of sales) after COGS has been paid
For example:
A result of 70% means that for every $1 of sales revenue, $0.70 has been made in GP
In order to analyse:
The GP margin reflects the ‘mark up’ between the firm’s purchasing costs and its selling prices
A low or declining GP margin suggests high supply costs and/or products are priced too low
A high GP margin suggests low supply costs/and or products priced to high
Alternative suppliers may need to be sourced if supply costs are too high
Some authors feel that 40% for retail businesses is good
The higher the GPR the better
Net profit Ratio (NPR)
Is derived from the Income Statement
It shows the amount of sales revenue that results in net profit. Businesses should aim for a high net profit ratio.
The NPR calculates how much NP is made (for every $1 of sales) after expenses have been paid.
For example
A result of 25% means that for every $1 of sales revenue, $0.25 has been made in NP.
In order to analyse:
The NP margin reflects the expenses of a business.
A low or declining NP margin (especially when the GP is relatively high) suggests excessive costs.
A high NP margin suggests low costs/expenses and sound financial management.
A low or declining NP margin suggests that expenses should be examined to see whether reductions can be made (e.g. staffing costs)
Some authors feel a 10-12% NPR is ‘good’
The higher the NPR the better
Return on Owners