ALLPPT.

com _ Free PowerPoint Templates, Diagrams and Charts

PROFITABILIT
Y
Let’s Review

What do you understand w

ith the concept of ‘profit’?
 
PROFITABILITY

- refers to the company’s abilit

y
to generate earnings. It is one
of the most important goals o
f
PROFITABILITY RATIO
- measure the ability of the company to generate income from the use
of its assets and invested capital as well as control its cost
The following are the commonly used profitability ratios:
These are the
- return on equity
- return on assets
- gross profit margin
- operating profit margin
- net profit margin.
Give examples of businesses that
you think are very profitable and
examples of businesses that you
think are not profitable.
 
Why businesses have different level
s of
profitability?
Return on equity measures the amount of net income earned in relation
to stockholders’ equity.
 
– ROE (return on equity) = Net income ÷ Stockholders’ equity
.
 
Return on assets measures the ability of a company to generate income
out of its resources/assets.
 
– ROA (return on asset) = Operating income ÷ Total assets
 
Gross profit margin shows how many pesos of gross profit is earned for
every peso of sale. It provides information regarding the ability of a c
ompany to cover its manufacturing cost from its sales.
Remember that gross profit is just sales less cost of goods or cost of serv
ices.
 
– Gross profit margin = Gross profit ÷ Sales
 
Operating profit margin shows how many pesos of operating profit i
s earned for every peso of sale. It measures the amount of income g
enerated from the core business of a company.
 
– Operating profit margin =Operating income ÷ Sales
 
Net profit margin measures how much net profit a company generat
es for every peso of sales or revenues that it generates.
 
– Net profit margin = Net income ÷ Sales
LET’S PRACTICE
Compute for financial ratios and present in front of the class
Sample Company Statement of Financial Position as of December
31, 2014
ASSETS   LIABILITIES AND STOCKHOLDERS’ EQUITY

Cash P 120,000.00 Accounts Payable P 70,000.00

Marketable Securities P 35,000.00 Short-term notes P 55,000.00

       

Accounts Receivable P 45,000.00 Current Liabilities P 125,000.00

Inventories P 130,000.00 Long-term debt P 2,700,000.00

       

Current Assets P 330,000.00 Total Liabilities P 2,825,000.00

Equipment P 2,970,000.00 Common stock P 500,000.00

Buildings P 1,600,000.00 Retained earnings P 1,575,000.00

       

Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00

       

Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00

Sample Company Statement of Financial Performance for the
Year Ended December 31, 2014
Sales Revenue P 2,000,000.00

Cost of Sales/Service P (1,300,000.00)

 
Gross Margin P 700,000.00

Operating Expenes P (199,000.00)

   
Operating Profit P 501,000.00

Other Income P 5,000.00

Other Expenses P (2,800.00)

 

Net Income before Tax P 503,200.00

Income Tax P (150,960.00)

 

Net Income after Tax P 352,240.00

 ANSWER KEY

Return on equity = 352,240/2,075,000

16.98%
Return on assets =352,240/4,900,000
7.19%
Gross profit margin =700,000/2,000,000
35%
Operating profit margin =501,000/2,000,000
25.05%
Net profit margin =352,240/2,000,00
17.61%
The ROE of 16.98% means that for every PHP 1 of s
tock holders’ equity, PHP0.1698 or 16.98 centavo
s was earned in 2014.
To be more meaningful, this rate of return is compa
red with the returns on alternative investments su
ch as the returns on time deposits and other fixed
income instru- ments.
For example, if the interest on time deposits is
only 2%, then the 16.98% ROE seems better.
However, before a conclusion is made that the 16.9
8% ROE is better than the time deposit rate of
2%, the risks associated with this company earning
16.98% has to be assessed.
Generally, the 2% time deposit rate is
guaranteed while the 16.98% R
OE is not. In 2014, ROE of Sample Com
pany was high, but what if in the futur
e, it will earn a negative ROE.

Is this possible for a company?

Yes! No manager in his/or sound mind wi
ll guarantee a specific rate of retu
rn, especially when that rate is relatively
high.
Why? Because in business, there are alw
ays risks.
A company which is doing so well this ye
ar may find itself with too many compet
itors in the future and these competitor
s may eat its share of the business in the
market and can make a profitable comp
Here is an extract of the statements of financial position
of the
three companies as of December 31, 2014

  JFC Petron Globe

       

Total Assets 54,119 391,324 179,507

       

Total Liabilities 26,041 277,632 124,969

       

Total Equity 28,078 113,692 54,538

Here is the condensed statement of financial performanc
e of the three companies for the year ended December 3
1, 2014.
  JFC Petron Globe

Sales Revenue 90,671 482,535 103,235

Cost of Sales/Service (73,728) (463,100) (10,661)

     

Gross Margin 16,943 19,435 92,574

Operating Expenses (10,806) (11,830.00) (59,506)

     

Operating Profit 6,137 7,605 33,068

Other Income 748 1,736 1,255

Other Expenses (126) (5,528) (14,940)

Net Income before Tax 6,759 3,813 19,383

Income Tax (1,271) (804) (6,011)

     

Net Income after Tax 5,488 3,009 13,372

       
Compute the ratios of the sample companie
s and
Compare the three companies using the rati
os
computed.
  JFC Petron Globe
       

Return on equity 19.55% 2.65% 24.52%

       

Return on assets 10.14% 0.77% 7.45%

       

Gross profit margin 18.69% 4.03% 89.67%

       

Operating profit margin 6.77% 1.58% 32.03%

       

Net profit margin 6.05% 0.62% 12.95%

Give possible reasons why
the sample companies hav
e
different ratios.
What could have possibly
caused these differences?
QUIZ:
1. Which of the following statements is true?
a. Gross profit margin is always less than net profit margin
b. Gross profit margin is always greater than net profit margin
c. Gross profit margin is can be less than or greater than net profit marg
in
 2. A business has a decreasing gross profit however, gross margin percenta
ge is
constant. What could be the possible reason?
 a. Sales is increasing, but cost of sales is decreasing
 b. Sales and cost of sales increase by the same percentage
 c. Sales and cost of sales decrease by the same percentage
 ESSAY:
Why it is important to use profitability ratios.