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Analyzing Financial Statements > Profitability Ratios
Profitability Ratios
• Basic Earning Power (BEP) Ratio
• Return on Common Equity
• Return on Total Assets
• Profit Margin
• Operating Margin
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Analyzing Financial Statements > Profitability Ratios
Basic Earning Power (BEP) Ratio
• The higher the BEP ratio, the more effective a company is at generating income
from its assets.
• Using EBIT instead of operating income means that the ratio considers all income
earned by the company, not just income from operating activity. This gives a more
complete picture of how the company makes money.
• BEP is useful for comparing firms with different tax situations and different
degrees of financial leverage.
Basic Earnings Power Ratio
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Analyzing Financial Statements > Profitability Ratios
Return on Common Equity
• ROE is net income divided by total shareholders' equity.
• ROE is also the product of return on assets (ROA) and financial leverage.
• ROE shows how well a company uses investment funds to generate earnings
growth. There is no standard for a good or bad ROE, but a higher ROE is better.
Return on Equity
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Analyzing Financial Statements > Profitability Ratios
Return on Total Assets
• ROA is net income divided by total assets.
• The ROA is the product of two common ratios: profit margin and asset turnover.
• A higher ROA is better, but there is no metric for a good or bad ROA. An ROA
depends on the company, the industry and the economic environment.
• ROA is based on the book value of assets, which can be starkly different from the
market value of assets.
Return on Assets
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Analyzing Financial Statements > Profitability Ratios
Profit Margin
• Profit margin is the profit divided by revenue.
• There are two types of profit margin: gross profit margin and net profit margin.
• A higher profit margin is better for the company, but there may be strategic
decisions made to lower the profit margin or to even have it be negative.
Net Profit Margin
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Analyzing Financial Statements > Profitability Ratios
Operating Margin
• The operating margin equals operating income divided by revenue.
• The operating margin shows how much profit a company makes for each dollar in
revenue. Since revenues and expenses are considered 'operating' in most
companies, this is a good way to measure a company's profitability.
• Although It is a good starting point for analyzing many companies, there are items
like interest and taxes that are not included in operating income. Therefore, the
operating margin is an imperfect measurement a company's profitability.
Operating margin formula
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Appendix
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Analyzing Financial Statements
Key terms
• asset Something or someone of any value; any portion of one's property or effects so considered.
• EBIT Earnings before interest and taxes. A measure of a business's profitability.
• equity Ownership, especially in terms of net monetary value, of a business.
• gross profit The difference between net sales and the cost of goods sold.
• net income Gross profit minus operating expenses and taxes.
• net profit The gross revenue minus all expenses.
• operating income Revenue - operating expenses. (Does not include other expenses such as taxes and depreciation).
• Return on Assets A measure of a company's profitability. Calculated by dividing the net income for an accounting period by the
average of the total assets the business held during that same period.
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Analyzing Financial Statements
Return on Assets
The return on assets ratio is net income divided by total assets. That can then be broken down into the product of profit margins and asset turnover.
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Analyzing Financial Statements
Basic Earnings Power Ratio
BEP is calculated as the ratio of Earnings Before Interest and Taxes to Total Assets.
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Analyzing Financial Statements
Operating margin formula
The operating margin is found by dividing net operating income by total revenue.
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Analyzing Financial Statements
Return on Equity
The return on equity is a ratio of net income to equity. It is a measure of how effective the equity is at generating income.
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Analyzing Financial Statements
Gross Profit Margin
The percentage of gross profit earned on the company's sales.
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Analyzing Financial Statements
Net Profit Margin
The percentage of net profit (gross profit minus all other expenses) earned on a company's sales.
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Analyzing Financial Statements
At the end of a fiscal year, a company had $8,000,000 in
revenues, $6,000,000 in operating expenses and $500,000 in
non-operating revenue. Its total assets at the end of the year was
$15,000,000. What is its Basic Earning Power ratio?
A) 0.1333
B) 0.5667
C) 1.667
D) 0.1667
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Analyzing Financial Statements
At the end of a fiscal year, a company had $8,000,000 in
revenues, $6,000,000 in operating expenses and $500,000 in
non-operating revenue. Its total assets at the end of the year was
$15,000,000. What is its Basic Earning Power ratio?
A) 0.1333
B) 0.5667
C) 1.667
D) 0.1667
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Analyzing Financial Statements
A company has assets of $2,000,000, net sales of $3,000,000,
and $1,500,000 in equity. Its net income is $10,000,000. What is
its return on equity?
A) 6.667
B) .15
C) 3.333
D) 5
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Analyzing Financial Statements
A company has assets of $2,000,000, net sales of $3,000,000,
and $1,500,000 in equity. Its net income is $10,000,000. What is
its return on equity?
A) 6.667
B) .15
C) 3.333
D) 5
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Analyzing Financial Statements
A company had $5,000,000 in total revenues for its fiscal year. Its
expenses for the year were $3,500,000. Its total assets were
$12,500,000. What is the company's return on assets for the fiscal
year?
A) 0.12
B) 0.40
C) 0.28
D) 0.70
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Analyzing Financial Statements
A company had $5,000,000 in total revenues for its fiscal year. Its
expenses for the year were $3,500,000. Its total assets were
$12,500,000. What is the company's return on assets for the fiscal
year?
A) 0.12
B) 0.40
C) 0.28
D) 0.70
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Analyzing Financial Statements
During a fiscal year, a company had $25,000,000 in total sales. It
had a cost of goods sold (COGS) of $18,000,000 and $4,000,000
in additional expenses. What is the company's gross profit
margin?
A) 12%
B) 16%
C) 28%
D) 33.33%
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Analyzing Financial Statements
During a fiscal year, a company had $25,000,000 in total sales. It
had a cost of goods sold (COGS) of $18,000,000 and $4,000,000
in additional expenses. What is the company's gross profit
margin?
A) 12%
B) 16%
C) 28%
D) 33.33%
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Analyzing Financial Statements
During a fiscal year, a company has $20,000,000 in revenue. Its
operating expenses are $17,000,000. What is the company's
operating margin?
A) 0.85
B) .73
C) 0.15
D) .13
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Analyzing Financial Statements
During a fiscal year, a company has $20,000,000 in revenue. Its
operating expenses are $17,000,000. What is the company's
operating margin?
A) 0.85
B) .73
C) 0.15
D) .13
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Analyzing Financial Statements
Attribution
• Wikipedia. "Return on assets Du Pont." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Return_on_assets_Du_Pont
• Wikipedia. "Return on assets." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Return_on_assets
• Wiktionary. "asset." CC BY-SA 3.0 http://en.wiktionary.org/wiki/asset
• Wiktionary. "net income." CC BY-SA 3.0 http://en.wiktionary.org/wiki/net+income
• Wikipedia. "Earnings before interest and taxes." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Earnings_before_interest_and_taxes
• Slideshare. "Financial Statement Analysis." CC BY-SA http://www.slideshare.net/nristreet/financial-statement-analysis12978969
• Connexions. "Profitability Ratios." CC BY 3.0 http://cnx.org/content/m15556/1.8/
• Wikipedia. "EBIT." CC BY-SA 3.0 http://en.wikipedia.org/wiki/EBIT
• Wikipedia. "Return on Assets." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Return%20on%20Assets
• Wikibooks. "GCSE Business Studies/Ratio Analysis." CC BY-SA 3.0
http://en.wikibooks.org/wiki/GCSE_Business_Studies/Ratio_Analysis
• Wikipedia. "Net profit." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Net_profit
• Wikipedia. "Profit margin." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Profit_margin
• Wiktionary. "gross profit." CC BY-SA 3.0 http://en.wiktionary.org/wiki/gross+profit
• Wiktionary. "net profit." CC BY-SA 3.0 http://en.wiktionary.org/wiki/net+profit
• Wikipedia. "Return on equity." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Return_on_equity
• Wikipedia. "Equity (finance)." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Equity_(finance)
• Wiktionary. "equity." CC BY-SA 3.0 http://en.wiktionary.org/wiki/equity
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Analyzing Financial Statements
• Wikipedia. "Financial ratio." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Financial_ratio
• Wikipedia. "Operating margin." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Operating_margin
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/operating-income
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