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FINANCIAL STATEMENT ANALYSIS
Profitability Ratios
All policies and decisions made by a company are driven by the
company's profitability goal. The previous ratios were designed to
provide information about the operations of a company. Another group
of ratios, Profitability Ratios, highlight the combined effects of
liquidity, asset management, and debt management. These ratios
include:
·
Profit Margin Ratio
·
Basic Earnings Power Ratio
·
Return on Total Assets Ratio
·
Return on Common Equity Ratio
Profit Margin Ratio
Percentage
of sales for
common
shareholders
The Profit Margin Ratio shows the percentage of sales that is left
for distribution to the common shareholders. The calculation is
N
ET
I
NCOME
A
VAILABLE TO
C
OMMON
S
HAREHOLDERS
divided by
S
ALES
for the
period. For our XYZ Corporation example, the calculation is:
Profit Margin
=
(Net Income to Common) / (Sales)
=
($6.2) / ($287.6)
=
2.16%
The Profit Margin Ratio reveals to the analyst how much profit is
being generated by the company for each dollar of sales.
Basic Earnings Power Ratio
Effective use
of assets to
generate earnings
The Basic Earnings Power Ratio is used to help compare firms with
different degrees of financial leverage and in different tax situations.
It provides the analyst with an idea of how effectively the assets are
used to generate earnings. The computation is
E
ARNINGS BEFORE
I
NTEREST
and
T
AXES
(EBIT)
divided by
T
OTAL
A
SSETS
.
Basic Earnings Power
=
(EBIT) / (Total Assets)
=
($22.5) / ($286.9)
=
7.84% of Total Assets