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Financial Ratios - Introduction to Profitability Ratios


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Introduction to Profitability Ratios

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Financial Ratios - Introduction to Profitability Ratios

  1. 1. Financial Ratios: Introduction to Profitability Ratios
  2. 2. m July 2016 Importance of Profitability Ratios • The profitability or financial performance is mainly summarised in the statement of profit and loss. • These ratios are calculated to analyse the earnings capacity of the business which is the outcome of utilization of resources employed in the business. • There is a close relationship between the profit and the efficiency with which the resources employed in the business are utilised. • These ratios are a class of financial metrics that are used to a business’s ability to generate earnings compared to its expenses. • For most of these ratios, having a higher value relative to a competitor's ratio or relative to the same ratio from a previous period indicates that the company is doing well.
  3. 3. m July 2016 Profitability Ratio : Gross Profit ratio Change in gross profit may be due change in selling price or cost of revenue from operations or a combination of both. Significance : It indicates gross margin on products sold. It also indicates the margin available to cover operating expenses, non-operating expenses. Gross profit ratio as a percentage of revenue from operations is computed to have an idea about gross margin. It is computed as follows Gross Profit Ratio = Gross Profit x 100 Net revenue from Operations Gross profit is a company’s total revenue (Equivalent to total Sales) minus the cost of goods sold. Gross profit is the profit a company makes after deducting the costs associated with making and selling its products.
  4. 4. m July 2016 Profitability Ratio : Net Profit ratio This number appears on a company’s income statement and is an important measure of how profitable the company is over a period of time. Net Income(NI) is a company’s total earning’s(or profit) is calculated by taking revenues and subtracting the costs of doing business such as depreciation, Interests, taxes and other expenses. It is computed as follows: Net Profit Ratio = Net Profit x 100 Revenue from Operations Net profit is also referred to as bottom line, net income or net earnings is a measure of the profitability of a venture after accounting for all costs. It is the actual profit without the inclusion of working expenses in the calculation of gross profit.
  5. 5. m July 2016 Profitability Ratio : Operating ratio Operating expenses include office expenses,admin expenses, selling expenses, depreciation and employee benefit expenses. Costs of operation is determined by excluding non – operating income and expenses. Also is referred to as Earnings before interest and tax(EBIT) ,operating profit represents the earnings power of a company with regard to revenues generated from ongoing operations. Operating Ratio = (Costs of revenue from operations + Operating expenses) x 100 Net revenue from Operations Operating profit is the profit earned from a firm’s normal core business operations. This value does not include any profits earned from the firm’s investments, such as earnings from firms in which the company has partial interests.
  6. 6. m July 2016 Profitability Ratio : Operating profit ratio It is very useful for inter-firm as well as intra firm comparisons. Lower operating ratio is a very healthy sign. This ratio is computed to express costs of operations excluding financial charges in relation to revenue from operations. It helps to analyse the performance of business and throws light on the operational efficiency of business. It is calculated as follows: Operating profit ratio = Operating profit x 100 Revenue from Operations Where operating profit = Revenue from Operations – Operating Costs Also known as Operating margin is a margin ratio used to measure a company’s pricing strategy and operating efficiency. Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for all variable costs such as wages, raw materials.
  7. 7. m July 2016 We would love to assist you Get in Touch Corporate Office: Vermillion Finalytics Private Limited 4D, Siddhivinayak Chambers, Gandhi Nagar, Opp MIG Cricket Club, Bandra (E), Mumbai – 400 051 Telephone : (022) – 2655 8760 Tollfree : 1800 – 228 - 005 Email : Website :