Profitability

Companies need profits to survive, without profits there would not be much point in continuing to trade. Profits vary from year to year, even from season to season. If there is a trend in profits, especially downwards, this should be identified as soon as possible.

Mark- Up Percentage

Mark-up percentage = Gross Profit x 100  =  Cost of Sales

How to interpret this ratio:

An organisation may price a product by adding a percentage to the cost of the product. Gross profit is the amount resulting from mark-ups on sold products. If the mark-up is very low, this could be an indication that products are being sold too cheaply. This ratio can also be used to ascertain if there was an increase in mark-ups from one period to the next.

Gross profit margin = gross profit ÷ sales

= R13 000 000 ÷ R51 000 000

= 25.49 %

Industry margin – 27.5 %

The gross margin indicates what portion of the selling price remains after paying for the stock. This is directly related to the pricing policy of either the company itself or its suppliers.

Increasing selling prices would increase the gross margin but could lead to less units being sold because of price competition. Buying for less will also increase the gross margin, but care should be taken to buy stock of the right quality.

Operating profit margin = operating income ÷ sales

= R4 000 000 ÷ R51 000 000

=7.84 %

Industry average – 8.1 %

The operating margin indicates what portion of the selling price remains to pay for interest, taxes and dividends. It is also an indication of the control over operating expenses. A decreasing operating profit margin while the gross profit margin stays constant, points to an increase in overheads without a comparable increase in prices and/or volumes.

Net income margin = net income ÷ sales

= R1 800 000 ÷ R51 000 000

= 3.53 %

Industry Ave – 3 %

The net profit margin measures the percentage remaining from each sales rand after all expenses have been paid. This ratio is often cited as the measure of a company's success. What constitutes a "good" net profit margin differs considerably across industries. A far better measure of success is to relate the net income to funds invested, as in the next ratio.

Return on Assets {ROA)

= Profit before interest and tax ÷ total assets

= R 4 000 000 ÷ R31 000 000

= 12.9%

Industry Ave – 4.2 %

Also called the return on investment, this ratio measures the overall effectiveness of management in generating after-tax profits with available assets (which equals total capital). The owners of Jimco will have to decide whether this is acceptable or not. If an increasing trend in ROA can be identified, this fairly low percentage may be quite acceptable.

The Return on owner’s equity (ROE) ratio is also calculated from the information given in the Income and Expenditure statement. This ratio is the net income of the business after it has paid the tax, to the owner’s equity; (Being the amount of money that the owner or owners have invested in the business, also known as the net worth of the business). It calculates the return that the owner is getting on the money he invested in the business. The results of this ratio are also shown as a percentage. It is calculated as follows:

Net income after tax x 100 = Owners’ equity

The Debt Equity Ratio shows how a business is financed; in other words how much money the business is lending in comparison to the amount of money that the owner has invested in the business.

It is important to note that if a business has borrowed more than what the owner has invested, it might be a sign that the owner lacks confidence in the business, or that he does not have the funds necessary to expand the business.

Debt Equity Ratio:

Total Debt ÷ Total Equity

This calculation requires the TOTAL Debt, that is, short term and long-term debt. It also requires the TOTAL equity which is the full amount that the owner has invested in the business together with any profits that the business has made since the business opened.

Total Asset Turnover

Total Asset Turnover = Sales ÷ Total Assets

How to interpret this ratio: The bigger the ratio, the more efficient the utilisation of total assets.

Fixed Asset Turnover

Fixed Asset Turnover = Sales ÷ Fixed Assets

How to interpret this ratio: Fixed assets such as equipment or property require a large investment and it is important that the sales justify this investment. The bigger the ratio, the more efficient the utilisation of fixed assets.

Click here to view a video that explains the Ratio Analysis Profitability.

Click here to view or download the Jimco Ltd balance sheet.