This document discusses three profitability ratios: return on sales (ROS), operating margin, and return of investment (ROI). ROS measures net income as a percentage of net sales and indicates how much profit is generated from each dollar of sales. Operating margin measures operating income as a percentage of net sales to show profitability after variable costs. ROI measures net income as a percentage of total non-current assets and working capital to evaluate how effectively a company generates income from its invested capital. Examples are provided to demonstrate calculating each ratio using financial data from an income statement and balance sheet. Key points about interpreting each ratio are also summarized.

1. Finance &
Investment
1
PRESENTED BY
Dr. Ramadan Babers
https://www.linkedin.com/in/ramadan-babers-phd-78976345/
Part_07

2. 2
• Profitability Ratios: Introduction
1
• Net Income to Net Sales (Return on Sales or
Profit Margin) (ROS)
2
• Operating Margin
3
• The Rate of Return on Investment (ROI)
Profitability Ratios

3. 3Profitability Ratios
Profitability ratios are financial
metrics used by analysts and
investors to measure and evaluate
the ability of a company to
generate income (profit) relative
to revenue, balance sheet assets

4. 4
1- Net Income to Net Sales (Return on Sales
or Profit Margin) (ROS)
2- Operating Margin
Profitability Ratios
3- The Rate of Return on Investment (ROI)

5. 5Example: Balance Sheet

6. 6Example: Income Statement
Gross margin = net sales – cost of goods sold
= 450000 – 127000 = 323000
Net operating income = gross margin –
operating expenses
= 323000 – 249000 = 74000
Net income before taxes = net operating
income – interest expense
= 74000 – 8000 = 66000
Net income = net income before taxes – less
income taxes
= 66000 – 19800 = 46200

7. 7Example: Income Statement
Gross margin = net sales – cost of goods sold
= 494000 – 140000 = 354000
Net operating income = gross margin –
operating expenses
= 354000 – 270000 = 84000

8. 8Example: useful information

9. 9
Profit margin and return on sales may also be referred to as:
"net operating margin" or simply "operating margin”
Return on Sales (ROS) =
Net Income
Net Sales (Total Sales)
Return on Sales (ROS) =
$ 53690
$ 494000
= %10.9
this is an essential ratio for management because it points to how
effectively business operations generate profit
1- Net Income to Net Sales (Return on Sales
or Profit Margin) (ROS)
ROS: Measures the proportion of the sales dollar which is retained as profit

10. 10
Investors often look to ROS
and profit margin when
comparing businesses in
separate industries,
something generally not
advisable when using
other financial ratios
ROS and profit margin do
not take into account the
type of financing a firm
employ, meaning without
factoring differences in
debt and equity spreads
into the equation.
1- Net Income to Net Sales (Return on Sales
or Profit Margin) (ROS) (Cont.)

11. 11
A measure of profitability. It indicates how much of each dollar of
revenues is left over after both costs of goods sold and operating
expenses are considered
Operating Margin =
Operating Income
Net Sales (Total Sales)
Operating Margin =
$ 84000
$ 494000
= % 17
2- Operating Margin

12. 12
2- Operating Margin (cont.)
• Operating margin is a
measurement of what
proportion of a company's
revenue is left over after paying
for variable costs of production
such as wages, raw materials,
etc
• A healthy operating margin is
required for a company to be
able to pay for its fixed costs,
such as interest on debt

13. 13
3- The Rate of Return on Investment (ROI)
Return on Investment =
Net Income
Total non-current Assets + Working Capital
• This ratio is an indicator of how company makes effective use of its assets
• A high ratio indicates effective asset use to generate income
It is the net gain or loss on an investment over a specified time period,
this simple rate of return is sometimes called the basic growth rate

14. End
Q & A
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