Profitability Ratios

1. UNIT 2
BUSINESS PERFORMANCE

2. What is required?
P4 –
Explain the performance of a selected business as
illustrated by the use of key financial ratios
M3 –
Analyse the reasons for the performance of a selected
business as illustrated by the use of key financial ratios
D2 –
Evaluate the significance of selected ratios in identifying
serious problems of business performance.

3. Ratios – An Introduction
1. PROFITABILITY
How effective a business is at generating profits
• Gross Profit Margin
• Net Profit Margin
• ROCE (Return on Capital Employed)
Activity (Match the formula to the definition and name of ratio)

4. PROFITABILITY RATIOS
• GROSS PROFIT
MARGIN
• Shows for every £1 of
sales how much is
retained in Gross Profit
• Formula
• Gross Profit x 100
Sales
Green planet
80589 x 100
151324
= 53.26%
Good?
Bad?
How to improve?

5. PROFITABILITY RATIOS
• NET PROFIT MARGIN
• Shows for every £1 of
sales how much is
retained in Net Profit
• Formula
Net Profit x 100
Sales
Green Planet
33845 x 100
151324
= 22.37%
Good?
Bad?
How to improve?

6. PROFITABILITY RATIOS
• Return on Capital
Employed (ROCE)
• Shows for every £1
invested in a business
the % return on that
investment
• Formula
Net Profit x 100
Capital Employed
EVERGREEN
33845 x 100
87198
= 38.82%
Good?
Bad?
How to improve?

7. Why is it necessary for a business to be profitable?
• A business needs to be profitable to ensure its long-term
survival. In the short run a business can make a loss but
losses cannot be sustained over long periods of time.
• A business needs a positive cash flow in order to meet its
everyday commitments, i.e. in order to pay wages and
creditors.

8. Task - Evergreen
Continue with your presentation including notes
1. Describe the performance of Evergreen using
PROFITABILITY ratios
a) Gross Profit Margin
b) Net Profit Margin
c) ROCE
2. SHOW THE FORMULA
3. SHOW YOUR ANSWER
4. Are the results good or bad?
5. Why?
6. Can you compare with industry average?
7. Suggest ways in which any concerns could be
rectified/improved?

9. Who is interested in ratio analysis/performance
evaluation?
• Bank managers
• Creditors
• Customs and Excise
• Debtors
• Employees
• Press

10. How do we assess whether a business is performing?
• By making comparisons
• Comparisons are made by:
• Comparing the performance of the business with its
performance in earlier years
• Comparing the performance of the business with that of
a similar business
• Comparing the performance of the business with sector
as a whole