Ratio Analysis: Profitability Ratios

Ratio Analysis
Profitability Ratios :-
Every business should earn sufficient profits to
survive and grow over a long period of time. In fact, efficiency of a
business is measured in terms of profits.
Profitability of a business may be measured in two ways:
1. Profitability in relation to sales
2. Profitability in relation to investment.
Profitability Ratios Based on Sales
These ratios are:
1.Gross Profit Ratio
2. Net Profit Ratio
3. Operating Ratio
Gross Profit Ratio( Gross Profit Margin) :-
Gross Profit Ratio = Gross profit *100

Net sales
Q1)
Net sales = Rs. 10,00,000
Cost of goods sold = Rs. 7,50,000
Gross profit = Sales – Cost of goods sold
= 10,00,000 – 7,50,000
= Rs.2,50,000
Gross profit ratio = Gross profit *100
Net sales
= 2,50,000 *100
10,00,000
= 25%
Net Operating Profit Ratio :-
Net operating profit ratio = Net operating profit *100
Net sales
Net operating profit is the gross profit minus all operating expenses.
Operating expenses consist of the following:
(i) Administrative expenses, like director’s fees , legal expenses, office
salaries, rent , insurance, etc.
(ii) Selling and distribution expenses, like advertising, travelling expenses,
salaries and commission of salesmen, etc.
Thus:
Net operating profit = Gross profit – Adm. and selling expenses.
Net Profit Ratio:-

This is the ratio of net profit to net sales. It is computed as:
Net profit ratio = Net profit *100
Net sales
Q2) The following is the Trading and Profit and Loss Account of XYZ Ltd
for the year ending 30 June 2012.
Rs. Rs.
To opening stock 38,000 By sales 2,50,000
To purchases 1,57,750 By closing stock 49,250
To carriage inwards 1,000
To wages 2,500
To Gross Profit 1,00,000
2,99,250 2,99,250
To Adm. Expenses 50,500 By Gross Profit 1,00,000
To selling expenses 9,500 By Non-operating 3,000
income(Dividend)
To interest paid 1,000
To Net Profit 42,000
1,03,000 1,03,000
Calculate :(a) Gross profit ratio (b) Net profit ratio
(c) Net operating ratio
Solution:-
(a) Gross profit ratio = Gross profit *100
Net sales
= 1,00,000 *100
2,50,000
= 40%
(b) Net profit ratio = Net profit *100
Net sales
= 42,000 *100
2,50,000
= 16.8%
(c) Net operating ratio = Net operating profit *100
Net sales
= 40,000 *100 = 16%

2,50,000
Net operating profit = Gross profit – Selling exp. – Adm.exp.
= 1,00,000 – 9,500 – 50,500
= Rs. 40,000
Operating Ratio :-
Operating ratio = Cost of goods sold + Operating expenses *100
Net sales
Profitability Ratio Based on Investments

1. Return on Investment (ROI), and
2. Return on Equity (ROE).
Return on Investment (ROI) or Return on Capital Employed (ROCE):-

This is the
most important test of profitability of a business. It measures the overall
profitability. It is ascertained by comparing the profit earned and the
capital( or funds) employed to earn it. It is calculated as follows:
ROI = Profit before interest & taxes *100
Capital employed
Q3) From the following Balance Sheet of Modi Steel Ltd, calculate Return on
Investment (ROI).
Liabilities Rs. Assets Rs.
Share capital 5,00,000 Land & Building 4,00,000
General Reserve 1,00,000 Plant& Machinery 3,00,000
Debentures 2,00,000 Stock 70,000
Creditors 50,000 Debtors 30,000
Cash at bank 50,000
8,50,000 8,50,000
Other information: Net Profit for the year is Rs. 1,20,000 and sales for the
year is Rs. 10,00,000.
Solution:-
Return on Investment (ROI) = Net Profit *100
Capital employed
= 1,20,000 *100
8,00,000
= 15%
It may also be computed as follows :
Land & Building 4,00,000
Add : Plant & Machinery 3,00,000
Fixed Assets 7,00,000
Add : Net working Capital :
Current Assets – Stock 70,000
Debtors 30,000
Cash 50,000
1,50,000
Less: Current Liabilities(Crs.) 50,000 1,00,000
Capital Employed 8,00,000
Return on Equity Capital

Return on Equity capital=Net profit after interest, taxes& pref. dividend
*100
Equity shareholders 'funds
Earning Per Share (EPS):-

This ratio measures the earnings per equity share,i.e., it
measures the profitability of the firm on a per share basis. It is calculated as
follows:
Earning per share = Net profit after taxes – Preference dividend
No. of equity shares
Dividend Payout Ratio (or Payout Ratio):-
It indicates the percentage of equity share
earnings distributed as dividends to equity shareholders. Its formula is:
Dividend Payout Ratio = Dividend per share

Earning per share(EPS)
Price Earning Ratio (P/E Ratio):-

This ratio is the market price of shares, expressed as
multiple of earning per shares (EPS). Its formula is:
P/E Ratio = Market price per equity share

Earning per share

Ratio Analysis: Profitability Ratios

Uploaded by

Copyright:

Available Formats

Ratio Analysis: Profitability Ratios

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ratio Analysis: Profitability Ratios

Uploaded by

Copyright:

Available Formats

Ratio Analysis

Gross Profit Ratio = Gross profit *100

Net Profit Ratio:-

= 40,000 *100 = 16%

Profitability Ratio Based on Investments

Return on Investment (ROI) or Return on Capital Employed (ROCE):-

Liabilities Rs. Assets Rs.

Share capital 5,00,000 Land & Building 4,00,000

General Reserve 1,00,000 Plant& Machinery 3,00,000

Debentures 2,00,000 Stock 70,000

Creditors 50,000 Debtors 30,000

Cash at bank 50,000

Return on Equity Capital

Earning Per Share (EPS):-

Dividend Payout Ratio = Dividend per share

Price Earning Ratio (P/E Ratio):-

P/E Ratio = Market price per equity share

You might also like