profitability

Examples of profitability in the following topics:

• Profit Margin

  • Profit margin measures the amount of profit a company earns from its sales and is calculated by dividing profit (gross or net) by sales.
  • Profit margin is one of the most used profitability ratios.
  • The higher the profit margin, the more profit a company earns on each sale.
  • Net profit is the gross profit minus all other expenses.
  • The gross profit margin calculation uses gross profit and the net profit margin calculation uses net profit .

• Operating Margin

  • The financial job of a company is to earn a profit, which is different than earning revenue.
  • If a company doesn't earn a profit, their revenues aren't helping the company grow.
  • The operating margin (also called the operating profit margin or return on sales) is a ratio that shines a light on how much money a company is actually making in profit.
  • The higher the ratio is, the more profitable the company is from its operations.
  • The operating margin is a useful tool for determining how profitable the operations of a company are, but not necessarily how profitable the company is as a whole.

• Return on Total Assets

  • The return on assets ratio (ROA) measures how effectively assets are being used for generating profit.
  • It is also a measure of how much the company relies on assets to generate profit.
  • The ROA is the product of two other common ratios - profit margin and asset turnover.
  • Profit margin is net income divided by sales, measuring the percent of each dollar in sales that is profit for the company.
  • That can then be broken down into the product of profit margins and asset turnover.

• The DuPont Equation

  • The DuPont equation is an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage.
  • Profit Margin = 400,000/1,000,000 = 40%.
  • Profit margin is a measure of profitability.
  • Profit margin is calculated by finding the net profit as a percentage of the total revenue.
  • Companies with low profit margins tend to have high asset turnover, while those with high profit margins tend to have low asset turnover.

• The Interest Rate Risk

  • Consequently, the bank's profits decline by $1.5 million ($1 M - $2.5 M = -$1.5 million).
  • Unfortunately, changes in the interest rates impact a bank's profits significantly.
  • If the interest-rate sensitive liabilities exceed the interest-rate sensitive assets, then rising interest rates cause banks' profits to plummet, while falling interest rates cause banks' profits to increase.
  • If the interest-rate sensitive liabilities are less than interest-rate sensitive assets, subsequently, increasing interest rates cause banks' profits to soar, while declining interest rates cause banks' profits to plummet.
  • Bank manager expects the bank's profit to rise.

• Steps Required to Forecast

  • Steps of forecast include problem definition, cash flow forecast, profit forecast, balance sheet forecast and profit determination.
  • There are two differences between a cash flow and a profit forecast.
  • The essential difference between cash flow and profit is that cash flow includes all items of income and expense, whereas profit seeks to match income and costs related to the generation of the income in a period of time; usually 12 months.
  • We now take the total of income and the operational costs into a Profit Statement.
  • Where there is profit, we need to then calculate income tax.

• MVA and EVA

  • ., and EVA is an estimate of a firm's economic profit.
  • In corporate finance, Economic Value Added or EVA, is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors (being shareholders and debt holders).
  • Quite simply, EVA is the profit earned by the firm, less the cost of financing the firm's capital.
  • EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost of capital and the economic capital.
  • where r is the return on investment capital (ROIC); c is the weighted average of cost of capital (WACC); K is the economic capital employed; NOPAT is the net operating profit after tax.

• Benefits and Risks of Operating Leverage

  • The use of operating leverage can multiply profits when a given break-even point is reached, but it can intensify losses when it is not.
  • When variable costs are lower, the contribution of sales to profits will be greater.
  • In other words, a company with higher operating leverage has the potential to generate much larger profits than a company with lower operating leverage.
  • Therefore, once a certain break-even point is reached, the contribution that sales make to profits is much higher than it would be if a greater portion of the costs were variable.
  • Just as the use of operating leverage can lead to greater profits, if a company is able to reach a given, break-even point, so too can the use of leverage drastically multiply losses if that point is not reached.

• Uses of the Income Statement

  • The purpose of the income statement is to show managers and investors whether the company was profitable during the period being reported.
  • The income statement, sometimes referred to as a profit & loss statement, reflects the revenues and expenses for a specific period of time.
  • The primary purpose of the income statement is to show managers and investors whether the company was profitable during the period being reported.
  • Lenders use the income statement to decide whether to provide the company with a loan, because a firm's ability to repay a loan in a timely manner ultimately depends on its profitability.
  • Explain how interested parties use the income statement to assess a company's profitability

• Classification

  • Ratio analysis consists of calculating financial performance using five basic types of ratios: profitability, liquidity, activity, debt, and market.
  • Financial statement analysis is the process of understanding the risk and profitability of a firm through analysis of reported financial information.
  • Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.