Profitability Measures
a-
Gross Profit Margin
b-
Operating profit margin
c-
Net Profit Margin
d-
Earnings Per Share (EPS)
e-
Return on Total Assets (ROA)
f-
Return On Common Equity (ROE)
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Sales – Revenue
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We divide Gross Profit , Operating Profit Margin and Net
Profit on Sales to
calculate Margin
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Less: Cost of goods sold
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Gross Profit
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Less Operating expenses
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Operating Profit
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Less Interest
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Less Tax
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Less Preferred stock Dividends
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Net Profit
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DuPont Analysis
Examples
Example 1
The data presented below shows actual figures for selected accounts of McKeon
Company for the fiscal year ended May 31, 2004, and selected budget figures for
the 2005 fiscal year. McKeon's controller is in the process of reviewing the
2005 budget and calculating some key ratios based on the budget. McKeon Company
monitors yield or return ratios using the average financial position of the
company. (Round all calculations to three decimal places if necessary.)
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Sales*
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$350,000
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Cost of goods sold
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160,000
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Interest expense
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3,000
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Income taxes (40% rate)
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48,000
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Dividends declared and paid in 2005
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60,000
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Administrative expense
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67,000
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*All sales are credit sales.
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Composition of Current Assets
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5/31/05
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5/31/04
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Cash
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$20,000
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$10,000
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Accounts receivable
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100,000
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70,000
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Inventory
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70,000
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80,000
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Other
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20,000
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20,000
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$210,000
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$180,000
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McKeon Company's total asset turnover for 2005 is
A - 0.805
B - 0.761
C - 0.722
D - 0.348
The 2005 return on assets for McKeon Company is
A - 0.261
B - 0.148
C - 0.157
D - 0.166
B - correct
0.761Total asset turnover is calculated as sales divided by average assets. Sales were $350,000 and average assets were $460,000 ($485,000 in 2002 and $435,000 in 2001). This gives us $350,000 ? $460,000 = .761.
C - correct
0.157The return on assets is net income after taxes and interest divided by average total assets of $460,000 ($485,000 in 2002 and $435,000 in 2001). Net income is $72,000 ($350,000 - $160,000 - $3,000 - $48,000 - $67,000). This gives us $72,000 ? $460,000 = .156. Dividends are not included in the calculation of net income because they are a distribution of that income.
0.761Total asset turnover is calculated as sales divided by average assets. Sales were $350,000 and average assets were $460,000 ($485,000 in 2002 and $435,000 in 2001). This gives us $350,000 ? $460,000 = .761.
C - correct
0.157The return on assets is net income after taxes and interest divided by average total assets of $460,000 ($485,000 in 2002 and $435,000 in 2001). Net income is $72,000 ($350,000 - $160,000 - $3,000 - $48,000 - $67,000). This gives us $72,000 ? $460,000 = .156. Dividends are not included in the calculation of net income because they are a distribution of that income.
Example 2
Return on investment may be calculated by multiplying total asset turnover by
A - Average collection period.
B - Profit margin.
C - Debt ratio.
D - Fixed-charge coverage.
B - correct
Profit margin. Return on investment is calculated as the profit of the company divided by the average total assets. The profit margin is calculated as profit divided by net sales. Total asset turnover is calculated as net sales divided by average total assets. Putting all of the formulas together, if we multiply the total asset turnover by profit margin we eliminate the net sales figure from each of the numbers and are left with the formula for return on investment – profit divided by average total assets.
A - Average collection period.
B - Profit margin.
C - Debt ratio.
D - Fixed-charge coverage.
B - correct
Profit margin. Return on investment is calculated as the profit of the company divided by the average total assets. The profit margin is calculated as profit divided by net sales. Total asset turnover is calculated as net sales divided by average total assets. Putting all of the formulas together, if we multiply the total asset turnover by profit margin we eliminate the net sales figure from each of the numbers and are left with the formula for return on investment – profit divided by average total assets.
Example 3
The ratio that measures a firm's ability to generate earnings from its
resources is
A - Days' sales in inventory.
B - Sales to working capital.
C - Days' sales in receivables.
D - Asset turnover.
D - correct
Asset turnover. Asset turnover is calculated as sales divided by total assets and is a measure of the company’s ability to generate earnings from all of its resources.
A - Days' sales in inventory.
B - Sales to working capital.
C - Days' sales in receivables.
D - Asset turnover.
D - correct
Asset turnover. Asset turnover is calculated as sales divided by total assets and is a measure of the company’s ability to generate earnings from all of its resources.
Example 4
Book value per common share represents the amount of shareholders' equity assigned
to each outstanding share of common stock. Which one of the following
statements about book value per common share is correct?
A - Market price per common share usually approximates book value per common share.
B - Book value per common share can be misleading because it is based on historical cost.
C - A market price per common share that is greater than book value per common share is an indication of an overvalued stock.
D - Book value per common share is the amount that would be paid to shareholders if the company were sold to another company.
B - correct
Book value per common share can be misleading because it is based on historical cost.Because the calculation of book value per share is based off of balance sheet amounts, it is very possible that the book value per share will not reflect the current situation of the company. This is demonstrated by assuming that a company owns an asset that has appreciated greatly in value while the company has held it. This asset will be recorded on the boos at its lower cost of acquisition and this will lead to an understated book value per share.
A - Market price per common share usually approximates book value per common share.
B - Book value per common share can be misleading because it is based on historical cost.
C - A market price per common share that is greater than book value per common share is an indication of an overvalued stock.
D - Book value per common share is the amount that would be paid to shareholders if the company were sold to another company.
B - correct
Book value per common share can be misleading because it is based on historical cost.Because the calculation of book value per share is based off of balance sheet amounts, it is very possible that the book value per share will not reflect the current situation of the company. This is demonstrated by assuming that a company owns an asset that has appreciated greatly in value while the company has held it. This asset will be recorded on the boos at its lower cost of acquisition and this will lead to an understated book value per share.
Example 5
Return on investment (ROI) is a term often used to express income earned on
capital invested in a business unit. A company's ROI is increased if
A - Sales increase by the same dollar amount as expenses and total assets.
B - Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.
C - Sales decrease by the same dollar amount that expenses increase.
D - Net profit margin on sales increases by the same percentage as total assets.
B - correct
Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.ROI is calculated as net income divided by total assets. One way to solve this problem is to simply set up a basic ROI of, for example, $100,000 ? $400,000 = .25, and then go through the choices changing these figures outlined in each option. If the sales remain the same and expenses are reduced, this will increase the net income to $150,000. This makes the ROI .375.
A - Sales increase by the same dollar amount as expenses and total assets.
B - Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.
C - Sales decrease by the same dollar amount that expenses increase.
D - Net profit margin on sales increases by the same percentage as total assets.
B - correct
Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.ROI is calculated as net income divided by total assets. One way to solve this problem is to simply set up a basic ROI of, for example, $100,000 ? $400,000 = .25, and then go through the choices changing these figures outlined in each option. If the sales remain the same and expenses are reduced, this will increase the net income to $150,000. This makes the ROI .375.
Example 6
A company has a 50% gross margin, general and administrative expenses of $50,
interest expense of $20, and net income of $10 for the year just ended. If the
corporate tax rate is 50%, the level of sales revenue for the year just ended
was
A - $90
B - $135
C - $150
D - $180
D - correct
$180If net income is $10 and the tax rate is 50%, we know that income before taxes is $20. We also know that the cost of goods sold is 50% of the sales price since the gross margin is 50%. Total expenses are $70 (general and administrative and interest). The formula for the calculation of the revenue is as follows (where R represents revenue): R - .5R – 70 = 20. Solving for R we get $180, which is the revenue of this company.
A - $90
B - $135
C - $150
D - $180
D - correct
$180If net income is $10 and the tax rate is 50%, we know that income before taxes is $20. We also know that the cost of goods sold is 50% of the sales price since the gross margin is 50%. Total expenses are $70 (general and administrative and interest). The formula for the calculation of the revenue is as follows (where R represents revenue): R - .5R – 70 = 20. Solving for R we get $180, which is the revenue of this company.
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