BKAF 3123

Chapter 5:
PROFITABILITY ANALYSIS
GROUP 7

5.1
PROFITABILITY
MEASURES

Net Profit Margin

Also referred to as return on sales
Reflects net income dollars generated by each
dollar of sales
Net profit margin = Net income before noncontrolling
interest, equity income and
nonrecurring
items
Net sales = 32 983
Net Sales
Gross profit = 10 940
Example: Operating profit = 3 130
Net profit = 2 126
Net Profit Margin = 6.45%

Total Asset Turnover

Measures the activity of the assets and the
ability of the firm to generate sales
through the use of the assets
Total asset turnover =
Net sales
Average Total
Asset
Example:
Net sales = 32 983
Beginning total assets of year =
14 940
Ending total assets of year = 14
998
Total asset turnover = 2.20
times

Return on Assets
Measures the ability to utilize assets to
create profits
Return on assets = Net income before noncontrolling
interest and
Nonrecurring Items
Average Total
Net profit = 2 126
Assets
Beginning assets of year = 14
940
Example
Ending assets of year = 14 998
Return on assets = 14.20%

DuPont Return on
Assets

Net profit margin, total asset turnover and return on

assets are reviewed together because of direct
influence
Termed Dupont on Assets
DuPont analysis separates return on assets into net
profit margin and total asset turnover
Separating the ratio into the two elements allows for
improved analysis of the causes for the change in the
percentage of return on assets
Return on assets = Net Profit Margin x Total Asset
Turnover

DuPont Return on Assets

Net Income Before

Net Income Before

Noncontrolling Interest

Noncontrolling Interest

and Nonrecurring Items

Average Total Assets

and Nonrecurring Items

Net sales

Net Sales
Average Total Assets

DuPont Analysis Variation

Consider only operating assets and income

Operating assets exclude
Construction in progress
Long-term investments
Intangibles
Other assets
Operating income includes only
Net sales less the cost of sales
Operating expenses
May give significantly different results
Reflective of ROA from primary business

Operating Income
Margin
Includes only operating income in the
numerator
Operating income margin = Operating
Income
Net
Net sales = 32 983
Sales
Gross profit = 10 940
Exercise
4 = 3 130
Operating profit
Net profit = 2 126
Operating income margin =
9.49%

Operating Asset Turnover

The operating asset turnover formula is the ratio
of a business formation's sales to its assets.
This ratio shows how efficiently a company can
use its assets to generate sales.
So, a higher ratio is always more favorable.
Higher turnover ratios mean the company is
using its operating assets more efficiently.

Example

Return on Operating Assets

Return on operating assets ratio is a

measure of firm's operating profitability.

Higher values of this ratio, indicate that
the company is more effectively in
managing its operating assets to produce
greater amounts of net income.

Example

DuPont Return on Operating Assets

It measure the combine effects of

operating income margin and operating
asset turnover.

Example

Sales to Fixed Assets

Measure the firms ability to make productive use
of its property, plant and equipment by
generating sales.
Since construction in progress does not
contribute to current sales, it should be exclude
from net fixed assets.
A high sales to fixed asset ratio shows effective or
optimal utilization of the fixed assets to generate
revenue.

Example

Return on Investment (ROI)

(ROI) applies to ratios measuring the
income earned on the invested capital.
It also measures the ability of the firm to
reward those who provide long-term funds
and to attract providers of future funds.

Example

Return on Total Equity

To measures the return to both common and preferred stockholders.
The higher the ratio percentage, the more efficient management is in
utilizing its equity base and the better return is to investors.

Preferred stock subject to mandatory redemption is termed

redeemable preferred stock. The redeemable preferred stock be
categorized separately from other eq- uity securities because the
shares must be redeemed in a manner similar to the repayment of
debt. Most companies do not have redeemable preferred stock. For
those firms that do, the redeemable preferred stock is excluded from
total equity and considered part of debt.

Example

Return on Common Equity

This ratio measures the return to the

common stockholder, the residual owner.

Example

5.2 TRENDS IN
PROFITABILITY

DEFINITION:

A
profitability
trend is the
evolution of
profit within
a business

Upward

Downwa
rd

5.3 SEGMENT
REPORTING

the reporting of the

operating segments
of a company in the
disclosures
accompanying its
financial statements.

required for
publicly-held
entities but not for
privately held
entities

DEFINITION
:

(GAAP & IFRS)

an operating segment
engages in business
activities from which it
may earn revenue and
incur expenses

intended to give
information to
investors and
creditors

These Rules To Determine Which Segments

Need To Be Reported:

Aggregate the results of two or more segments

Report a segment if it has at least 10% of the:
* revenues
* profit or loss
* combined assets of the entity
If the total revenue of the segments that are
selected less than 75% of the entities total
revenue, then add more segment until reach that
threshold
Can add more segments beyond the minimum,
but consider a reduction if the total exceeds ten
segments.

The information should include in segment

reporting:

The factors used to identify reportable segments

The types of products and services sold by each segment
The basis of organization (such as being organized around
a geographic region, product line, and so forth)
Revenues
Interest expense

Depreciation and amortization

Material expense items
Equity method interests in other entities
Income tax expense or income
Other material non-cash items
Profit or loss

5.4 REVENUES BY
MAJOR PRODUCT LINE

5.5 Gain and Losses from

Prior Period Adjustment

 Gain or loss from prior period adjustments are resulted

from:
Changes in accounting principles
Realization of income tax benefits of pre-acquisition
operating loss carry forward of purchased subsidiaries
Changes in accounting entity
Corrections of errors in prior period
It never go through and recognized in income statement
It charged directly to retained earning.

5.6 Interim
Report

Quarterly
information
disclosed
Additional
source of
information on
profitability

Unaudited
financial
reports that
cover fiscal
periods of less
than one year

Interim
Report

Help the analyst

determine trends
and identify
trouble areas
before the yearend report
available

Disclose the
seasonal nature
of the firms
activities
Less reliable
compare to
annual report

5.6 Interim Report (contd)

Data included in interim reports are:
1. Income statement amounts
Sales or gross revenues
Provision for income taxes
Extraordinary items and tax effect
Cumulative effect of accounting change
Net income
2. Earnings per share
3. Seasonal information
4. Significant changes in income tax provision or estimate
5. Disposal of segments of business and unusual items material to the period
6. Contingent items
7. Changes in accounting principles or estimates
8. Significant changes in financial position

Question

Required :

1.
2.
3.

Net profit margin

Return on assets
Total assets turnover

4.
5.

Return on total equity

Sales to fixed asset

THANK YOU..