FR - Profitability Ratios

Monday, 23 June 2008 13:52

Ratios are a way to evaluate the performance of your business and identify potential problems. Each ratio informs you about factors such as the earning power, solvency, efficiency, and debt load of your business. They are used to measure the relationship between 2 or more components of the financial statements and have greater meaning when the results are compared to industry standards for businesses of similar size and activity Profitability ratios: how much profit is being generated · Earnings per share · Net profit margin · Return on shareholders' equity · Return on total assets· Coverage ratio Earnings per share Calculation: ( net income - preferred dividends ) / number of common shares Measures the after-tax earnings generated for each share of common stock. Earnings Per Share does not apply to preferred shareholders as they receive dividends before any dividends are made to common shareholders. Preferred dividends are subtracted from net income to calculate the amount available to common shareholders. Example: Earnings per share : $ 4.64 Indicates the number of dollars of income have been earned for each share of common stock. This result may be considered positive or negative, depending on the industry standard for companies of similar size and activity Net profit margin Calculation: net profit after taxes / net sales Also called the Return on Sales Ratio, it shows the after-tax profit (net income) generated by each sales dollar by measuring the percentage of sales revenue retained by the company after operating expenses, creditor interest expenses, and income taxes have been paid. Example: Net profit margin : $ 20.70 Indicates the number of profit dollars generated for each $100 in sales. This result may be considered positive or negative, depending on the industry standard for companies of similar size and activity Return on shareholders' equity Calculation: ( net income for the year - taxes - interest ) / shareholders' equity Measures the rate of return the shareholders receive on their investment in your business. Net Income for the Year is after taxes and interest because the shareholders are only entitled to the balance. Example: Return on shareholders' equity : $ 0.45 Indicates the dollar amount of after-tax and after-interest profit generated for each $1 of equity. This result can positive or negative, depending on the industry standard for companies of similar size and activity. Return on total assets Calculation: income from operations / average total assets Measures the efficiency of assets used to generate income by the amount of profit generated for every $100 invested in assets. Income from Operations excludes any expenses such as income taxes and financing charges. Average Total Assets are used due to the variation in the amount of assets used by the business. Average Total Assets = Average Current Assets + Average Fixed Assets. Example: Return on total assets : 37.16 A higher ratio result than industry standards usually indicates an efficient use of assets. There are several factors to consider before drawing conclusions from this ratio such as seasonal variability in sales and whether assets are bought or leased Coverage ratio Calculation: profit before interest and taxes / annual interest and bank charges Also known as the Number of Times Interest Earned Ratio, it measures the business' capacity to generate enough income to pay the interest on its loans. Example: Coverage ratio : 12.84 This result may be considered positive or negative, depending on the industry standard for companies of similar size and activity. Long-term investors seek assurance that the business in which they are investing can sufficiently cover its interest requirements by a comfortable margin. Therefore, a larger value for the Coverage Ratio is preferred as it indicates a limited risk to term lenders. A lower value may indicate that the debt load is too high for profitability and that the business may not be able to meet all of its obligations.

Last Updated ( Tuesday, 29 July 2008 06:19 )