Financial Statement Analysis - Profitability Ratios

Profitability Ratios show how successful a company is in terms of generating returns or profits on the Investment that it has made in the business. If a business is Liquid and Efficient it should also be Profitable.

##### 01 FIRST PROFITABILITY RATIO

Return on Sales or Profit Margin (%): The Profit Margin of a company determines its ability to withstand competition and adverse conditions like rising costs, falling prices or declining sales in the future. The ratio measures the percentage of profits earned per dollar of sales and thus is a measure of efficiency of the company.

The Formula:

Return on Sales or Profit Margin = (Net Profit / Net Sales) x 100

An example from our Balance sheet and Income Statement:

Total Net Profit after Interest and Taxes (from Income Statement) = \$5,142

Net Sales (from Income Statement) = \$727,116

Return on Sales or Profit Margin = [ \$5,142 / \$727,116] x 100

Return on Sales or Profit Margin = 0.71%

The Interpretation:

Lumber & Building Supply Company makes 0.71 cents on every \$1.00 of Sale

Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.

##### 02 SECOND PROFITABILITY RATIO

Return on Assets: The Return on Assets of a company determines its ability to utilize the Assets employed in the company efficiently and effectively to earn a good return. The ratio measures the percentage of profits earned per dollar of Asset and thus is a measure of efficiency of the company in generating profits on its Assets.

The Formula:

Return on Assets = (Net Profit / Total Assets) x 100

An example from our Balance sheet and Income Statement:

Total Net Profit after Interest and Taxes (from Income Statement) = \$5,142

Total Assets (from Balance sheet) = \$320,044

Return on Assets = [ \$5,142 / \$320,044] x 100

Return on Assets = 1.60%

The Interpretation:

Lumber & Building Supply Company generates makes 1.60% return on the Assets that it employs in its operations.

Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.

##### 03 THIRD PROFITABILITY RATIO

Return on Equity or Net Worth: The Return on Equity of a company measures the ability of the management of the company to generate adequate returns for the capital invested by the owners of a company. Generally a return of 10% would be desirable to provide dividends to owners and have funds for future growth of the company

The Formula:

Return on Equity or Net Worth = (Net Profit / Net Worth or Owners Equity) x 100

Net Worth or Owners Equity = Total Assets (minus) Total Liability

An example from our Balance sheet and Income Statement:

Total Net Profit after Interest and Taxes (from Income Statement) = \$5,142

Net Worth (from Balance sheet) = \$133,522

Return on Net Worth = [ \$5,142 / \$133,522] x 100

Return on Equity or Return on Net Worth = 3.85%

The Interpretation:

Lumber & Building Supply Company generates a 3.85% percent return on the capital invested by the owners of the company.

Review the Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the same industry.