Profitability Ratios
Profitability Ratios
Profitability ratios measure two aspects of a corporation’s profits: (1) those elements of operations that contribute to profit and (2) the relationship of profit to total investment and investment by stockholders. The first group of profitability ratios [gross profit (or gross margin) percentage, operating margin percentage, and net profit margin percentage] expresses income statement elements as percentages of net sales. The second group of profitability ratios (return on assets and return on equity) divides measures of income by measures of investment.
• Gross Profit (or Gross Margin) Percentage
Gross profit percentage is measurement of the proportion of each sales dollar that is available to pay other expenses and provide profit for owners. The gross profit percentage indicates the effectiveness of pricing, marketing, purchasing, and production decisions. In evaluating the gross profit, operating margin, and net profit margin percentage, it is important to recognize that there is substantial variation in profit margins from industry to industry.
• Operating Margin Percentage
The operating margin percentage measures the profitability of a company’s operations in relation to its sales. All operating revenues and expenses are included in income from operations, but expenses, revenues, gains, and losses that are unrelated to operations are excluded. For example, a retailer would exclude interest revenues produced by its credit activities from income from operations.
• Net Profit Margin Percentage
The net profit margin percentage measures the proportion of each sales dollar that is profit.
• Return on Assets
The return on assets ratio measures the profit earned by a corporation through use of all its capital, or the total of the investment by both creditors and owners. Profit, or return, is determined by adding interest expense net of tax to net income.
Interest expense net of tax is calculated as follows:
Interest
Profitability ratios measure two aspects of a corporation’s profits: (1) those elements of operations that contribute to profit and (2) the relationship of profit to total investment and investment by stockholders. The first group of profitability ratios [gross profit (or gross margin) percentage, operating margin percentage, and net profit margin percentage] expresses income statement elements as percentages of net sales. The second group of profitability ratios (return on assets and return on equity) divides measures of income by measures of investment.
• Gross Profit (or Gross Margin) Percentage
Gross profit percentage is measurement of the proportion of each sales dollar that is available to pay other expenses and provide profit for owners. The gross profit percentage indicates the effectiveness of pricing, marketing, purchasing, and production decisions. In evaluating the gross profit, operating margin, and net profit margin percentage, it is important to recognize that there is substantial variation in profit margins from industry to industry.
• Operating Margin Percentage
The operating margin percentage measures the profitability of a company’s operations in relation to its sales. All operating revenues and expenses are included in income from operations, but expenses, revenues, gains, and losses that are unrelated to operations are excluded. For example, a retailer would exclude interest revenues produced by its credit activities from income from operations.
• Net Profit Margin Percentage
The net profit margin percentage measures the proportion of each sales dollar that is profit.
• Return on Assets
The return on assets ratio measures the profit earned by a corporation through use of all its capital, or the total of the investment by both creditors and owners. Profit, or return, is determined by adding interest expense net of tax to net income.
Interest expense net of tax is calculated as follows:
Interest
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