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The profit earned from a firm's normal core business operations. This value does not include any
profit earned from the firm's investments (such as earnings from firms in which the company has
partial interest) and the effects of interest and taxes.
Calculated as:
Overall, the company's operating profit is $40 million. This is calculated as the $50 million in
operating revenue million minus the $10 million in production costs. The other $10 million and
$3.5 million in earnings are not included in operating income because they are investment
income.
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Operating Profitability can be divided into measurements of return on sales and return on
investment.
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This shows the average amount of profit considering only sales and the cost of the items sold.
This tells how much profit the product or service is making without overhead considerations. As
such, it indicates the efficiency of operations as well as how products are priced. Wide variations
occur from industry to industry.
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= gross profit / net sales
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This ratio indicates the profitability of current operations. This ratio does not take into account
the company's capital and tax structure.
^
m
= operating income/net sales
Where:
m
= earnings before tax and interest
from continuing operations
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This ratio indicates the profitability of current operations. This ratio does not take into account
the company's capital, non-cash expenses or tax structure.
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= earnings before tax, depreciation and
amortization
net sales
This ratio indicates the profitability of Company's operations. This ratio does not take into
account the company's tax structure.
^
= Earning before tax/sales
This ratio indicates the profitability of a company's operations.
^
Net margin = net income/sales
= contribution / sales
Jonathan Roe
Jonathan Roe enjoyed a liberal arts education at Miami University where he studied philosophy
and business. He is currently working on an MBA at the Weatherhead School of Management in
Cleveland, Ohio, while working full time as a corporate banker. Relying on his wide-ranging
education, he writes for a variety of companies.
Operating profitability on an income statement represents the amount of money made after all
costs of goods sold and selling, general and administrative expenses have been subtracted from
all regular operating revenue. It does not include "below the line" items such as interest expense,
taxes, gains or losses on assets or securities, or one-time events such as goodwill impairment or
lawsuit settlements. Operating profitability is a good indicator of the normal profitability of a
business.
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Y To understand what operating profitability means, a person must first understand
what an income statement shows and what each section represents. Unlike a
balance sheet, an income statement is cumulative. The numbers presented on the
income statement represent the total revenue and associated costs earned or
incurred for that period.
Y The income statement is broken down into four main sections. At the top of the
statement is the amount of revenue taken in during the period from the firm's
main business activities. It does not include non-revenue-based income such as
interest earned or gains on asset sales.
Y Beneath revenues is cost of goods sold. This represents the direct costs that were
incurred to produce whatever it is the firm is selling. It includes direct labor, the
materials used in production and overhead. Subtracting cost of goods sold from
total revenue gives you gross profit.
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Y Operating profitability is a useful measure of performance because it allows an
analyst to ignore the noise of other things that might be going on with the firm. If
a company is having to pay out money because of a lawsuit, the stock market has
tanked and they must write down the value of their investment portfolio, or they
are selling assets that have gained or lost value from when they were initially
purchased, then net profit will obscure the profitability of the core enterprise. By
looking at operating profitability and disregarding the "below the line" items, an
analyst or business owner can see how the business is truly performing.
inventory
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The raw materials, work-in-process goods and completely finished goods that are considered to
be the portion of a business's assets that are ready or will be ready for sale. Inventory represents
one of the most important assets that most businesses possess, because the turnover of
inventory represents one of the primary sources of revenue generation and subsequent earnings
for the company's shareholders/owners.
Inventory management forecasts and strategies, such as a just-in-time inventory system, can help
minimize inventory costs because goods are created or received as inventory only when needed.
1. A company's merchandise, raw materials, and finished and unfinished products which have
not yet been sold. These are considered liquid assets, since they can be converted into cash quite
easily. There are various means of valuing these assets, but to be conservative the lowest value is
usually used in financial statements.
2. The securities bought by a broker or dealer in order to resell them. For the period that the
broker or dealer holds the securities in inventory, he/she is bearing the risk related to the
securities, which may change in price.
Money which is owed to a company by a customer for products and services provided on credit.
This is treated as a current asset on a balance sheet. A specific sale is generally only treated as an
account receivable after the customer is sent an invoice.
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Money owed by customers (individuals or corporations) to another entity in exchange for goods
or services that have been delivered or used, but not yet paid for. Receivables usually come in
the form of operating lines of credit and are usually due within a relatively short time period,
ranging from a few days to a year.
Accounts receivable are not limited to businesses - individuals have them as well. People get
receivables from their employers in the form of a monthly or bi-weekly paycheck. They are
legally owed this money for services (work) already provided.
When a company owes debts to its suppliers or other parties, these are known as accounts
payable.
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3
An accounting entry that represents an entity's obligation to pay off a short-term debt to its
creditors. The accounts payable entry is found on a balance sheet under the heading current
liabilities.
Another common usage of AP refers to a business department or division that is responsible for
making payments owed by the company to suppliers and other creditors.
Payables are not limited to corporations. At the household level, people are also subject to bill
payment for goods or services provided to them by creditors. For example, the phone company,
the gas company and the cable company are types of creditors. Each one of these creditors
provide a service first and then bills the customer after the fact. The payable is essentially a
short-term IOU from a customer to the creditor.
Each demands payment for goods or services rendered and must be paid accordingly. If people
or companies don't pay their bills, they are considered to be in default.
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A metric that expresses the length of time, in days, that it takes for a company to
convert resource inputs into cash flows. The cash conversion cycle attempts to measure the
amount of time each net input dollar is tied up in the production and sales process before it is
converted into cash through sales to customers. This metric looks at the amount of time needed
to sell inventory, the amount of time needed to collect receivables and the length of time the
company is afforded to pay its bills without incurring penalties.
Calculated as:
Where:
DIO represents days inventory outstanding
DSO represents days sales outstanding
DPO represents days payable outstanding
This cycle is extremely important for retailers and similar businesses. This measure illustrates
how quickly a company can convert its products into cash through sales. The shorter the cycle,
the less time capital is tied up in the business process, and thus the better for the company's
bottom line.