Thursday 18 May 2017

Profitability ratio analysis

Profitability ratio analysis

A Profitability ratio analysis is a good way to measure company's performance. Profitability ratios can be divided into two types: margins, indicating the firm's ability to transform money from sales into profits, and returns, showing the ability of a company to generate returns for its shareholders.

Profitability is the ability of a company to gain profits in a given period. The profitability is the ability of a company making a profit  at the level of sales, assets, and capital stock. The company is the ability to generate profit on which to base the company's dividend distribution.


Profitability describe the business entity's ability to generate a profit by using the entire capital owned. In turn, the profitability of an enterprise will affect investors on investment policy have done. The company's ability to generate profits will be able to attract investors to invest their funds in order to expand his business, in contrast to the low level of profitability will cause investors withdraw funds. As for the company itself can be used as evaluation of profitability over the effectiveness of the management of the business entity.

"Profitability is the net result of a large number of policies and decisions. The ratio examined thus far reveals some interesting thing about the wry the firm operates, but the profitability ratio shows the combined objects of liquidity, asset management, and debt management on operating assets. " 

The profitability is the ability of a firm to generate earnings. It is measured relative to a number of bases, such as assets, sales, and investment ". Gibson defined the profitability is the ability of a company to improve the bottom line of the company, profitability is measured by comparing the profits that accrue to the company with a number of estimates that became a benchmark of success companies such as company assets, sales and investments. So you can note the effectiveness of financial management and assets by the company.

In the operational activities of the company, profit is an important element in ensuring the continuity of the company. With the capability of obtaining profits by using all the resources of the company then the company's goals will be achieved. All users of these resources allow companies to earn high profits. Profit is the result of revenue by sales reduced by sales loads and other loads.

Of the use of profitability for the company as well as for parties outside the company aims to (1) measure or calculate the profit the company earned in one period, (2) assess the position of the company's profit for the previous year by year now, (3 development of the profit rate) from time to time, and (4) measure the productivity of the entire Fund company that used its own capital or loan capital.

Profitability Ratios

The Profitability Ratios are used to measure the effectiveness of the overall management addressed by great small profitability gained in conjunction with the sale or investment. The better profitability ratio then the better illustrates the ability of the high gain of the company.

The ratio of profitability is a model of analysis that is comparative financial data. Of the use of profitability ratio can be done using a comparison between various components in the financial statements, particularly the financial statements balance sheet and income statement. Measurements can be done for several periods of operation. The goal is to make it look the development of companies in a certain span of time, either decrease or increase, while searching for the cause of such changes.

Ratio analysis of profitability and an example

analysis of ratio of profitability is a way of measuring the ability of effort in making a profit during a certain period, through the sale of assets , and capital. Ratio analysis in profitability calculations using ratios Gross Profit Margin (GPM), Operating Profit Margins (OPM), the Net Profit Margin (NPM), Total Assets Turnover (TAT), Return on Investment (ROI) and Return on Equity (ROE). Each of the profitability ratios are described below.

Gross Profit Margin (GPM)

GPM is the percentage of sales compared to the gross profit:

Gross Profit Margin (GPM) Formula

The ratio of gross profit margin is GPM. Gross profit margin shows the relationship between selling and loads of goods sold.

Operating Profit Margins (OPM)

OPM is a ratio that depicts pure profit received on every US Doller.

Operating Profit Margins (OPM) formula

On the ratio of OPM, the number operating profit used in the calculation of derived from the principal business activities of the company.

Net Profit Margin (NPM)

NPM is the ratio between the net profit (net profit) IE sales after the tax is reduced by the whole, then compared with sales.

Net Profit Margin (NPM) Formula

NPM ratio measures the Dollar in profit generated by the sale of Dollar each. This ratio gives an overview of profit to shareholders as a percentage of sales.

Total Assets Turnover (TAT)

TAT indicate the level of efficiency of the use of the overall assets of the company in certain sales:

Total Assets Turnover (TAT) Formula

TAT is important for lenders and owners of the company, but it is more important for the management of the company because it will show whether or not efficient use of the entire assets within the company.

Return on Investment (ROI)

Measurement of the ROI is the ability of the company as a whole in generating profits with the total number of the available assets in the company.

Return on Investment (ROI) Formula

This ratio is looking at the extent to which investments have been implanted to provide refund profits as expected.

Return on Equity (ROE)

ROE is a measurement of earnings (income) that are available to the owners of the companies over invested capital in the company.

Return on Equity (ROE) Formula

This ratio is used to find out the extent to which a firm is in the use of resources in order to be able to give the which are owned a return on equity.

Analysis of the Profitability Ratio

An Analysis of the Profitability Ratios below merely examples and the results of each calculation is simplified in the form of ratios the following table:

Profitability ratio analysis

Gross Profit Margin (GPM)

ratio of profitability calculation Table above shows that the value of the X company GPM in 2010, 2011, and 2012 respectively amounted to 4.52%; 3.55%; 3.23% with an average value of 3.77%, means of sales volume or each $ 100 of net sales will generate a gross profit of $ 4.52; Us $3.55; and USD 3.23.

The value of the GPM is below industry standards, namely amounting to 26.6%. The value of the GPM tend to decline from year to year and the largest decline occurred in the year 2012, namely of 3.23%. This is due to a drop in sales occurred so that the resulting gross profit being low. The value of the GPM down each year show that Company X has the ability is not good in generating gross profit. The decline occurred because the selling followed by cost of goods sold gross profit thus generated is quite low.

Operating Profit Margins (OPM)

the profitability ratio Table shows the value of OPM on company X for the years 2010, 2011, and 2012 is a row of 4.65%; 4.55%; 4.05% with an average rating of 4.42%, meaning that the company generated operating profit of 4.65% X; 4.55%; and 4.05% of the volume of sales or any $ 100 of net sales will generate operating profit of $ 4.65; $ 4,55; and $ 4.05.

The average value of the acquired Company OPM X when compared to the industry standard which is the value of 4.6% was nearly meet industry standard values, it indicates that the advantage of the yielding ability operational activities undertaken already good enough. The value of the OPM can be improved if company X is able to manage the use of operational costs as well as with an increase in sales, so that the operating profit can be obtained for the maximum.

Net Profit Margin (NPM)

the table above shows the profitability ratio is the value of the NPM in Company X for the years 2010, 2011, and 2012 is a row of 4.07%; 3.20%; 2.90% with an average value of 3.39%. Based on the analysis of NPM, it can be noted that the value of the NPM in the year 2010 amounted to 4.07%, which means that each $ 100, sales will generate a profit of $ net 4.07. In the year 2011 going decline in IE of 3.20%, which means that each $ 100, sales will generate a profit of $ net 3.20. In the year 2012 is happening again i.e. decline of 2.90%, which means that each $ 100, sales will generate a profit of $ 2.90 net.

The results of the calculation of the NPM can be gained an idea of how much profit the company x. NPM achieved level of Company X during the last three years are likely to decline from year to year. This is because the level of sales or revenue services have not experienced such a huge improvement.

A decrease in the NPM is usually caused due to lack of sales before tax deductible amount and is not followed by an increase in net sales. While the increase was caused by rising NPM net income tax followed by active rise in net sales.

Total Assets Turnover (TAT)

Value of TAT on company X for the years 2010, 2011, and 2012 is a row of 5.96 times; 5.36 times; 5.51 times with an average of 5.61 times, meaning that the resulting sales amounted to 5.96 times; 5.36 times; 5.51 times of total assets. The average value of the TAT on company X is above industry standards, namely in the amount of 1.8 times.

The value of the TAT each year undergo fluctuations and tend to decrease. The decline in the value of the TAT from year to year shows that the lack of efficiency of the use of the whole capital owned in generating sales. Decrease of TAT from year to year due to the existence of the percentage increase in sales or revenues of the smaller service compared to the percentage increase in assets. The financial performance of the company X views TAT good since the increasing ratio of TAT means more efficient use of overall assets in generating high sales rate.

Return on Investment (ROI)

From the table above shows the calculation of the results obtained as a result that the value of ROI on company X year 2010 amounted to 24.24%, in the year 2011 decreased to 17.14%, and in 2012 increase be 15.99%, whereas the average of 19.12% of sales, in every $ 100, total assets used gives a profit of $ 24.24; $ 17.14; Us $15.99. The condition of the ups and downs of the value of ROI in 2010 to 2012 indicates that use of the assets of the company have not been efficient and low levels of profit generated by the overall use of the assets. The increase in the value of the company has been able to demonstrate ROI managing the assets available to the maximum in order to produce the optimal benefits. ROI can be improved by pressing operational costs or the cost of goods sold so that the earnings obtained are higher.

Return on Equity (ROE)

the calculation result in the table shows the value of the ROE of the years 2010 until 2012 respectively is of 42.12%; 21.91%; 19.38%, with an average of 27.80%, meaning that the level of income earned over a business's own capital invested is 27.80% or in any $ 100, own capital invested give a profit of $ 27.80. The value of the ROE on company X is above industry standards, namely of 14.04%. The results of calculations of ROE can be aware that the value of the ROE declined from the year 2010, 2011, and 2012. The decline is caused due to high operating costs, making the profit achieved is not comparable to the capital issued, so that private equity's ability to generate net profits declined from year to year.


Ratio analysis on co$orate profitability X year for the period 2010 to 2012 shows a declining trend, namely to GPM (4.52% to 3.23%), OPM (4.65% to 4.05%), NPM (4.07% to 2.90%), TAT (5.96 times to 5.51 times), ROI (24.24% to 15.99%), and ROE (42.12% to 19.38%).

Recommendation: the company X needs to be doing planning against a profitability ratio analysis so that the use of the assets or capital can function optimally.

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