Profitability PPT

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Analysis of
Financial StatementsProfitability ratio
Presented by:
Sumit kumar

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What is Profitability?
Is it always all about success?
It is about achieving what is expected orbetter.
It is about benchmarks and goals.
It is about managing risk and minimising
these. Profit means that revenues are higher than
costs.

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Profit Mastery Content
Seven Steps to Building Value
1. Plan Properly
2. Monitor Financial position
3. Understand Price, Volume, Cost
4. Manage Cash Flow
5. Manage Growth
6. Finance Properly
7. Plan for Transition

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Profitability can be achieved by:
Selling More
Selling at a better margin
Better use of Debt Capital More efficient use of assets (Ryanair Vs BA)

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Assets = Liabilities + Net Worth
BalanceSheet
Uses of Profits:
1. To pay for new assets2. To pay off debt3. To pay dividends to owners
Sales
IncomeStatement
Net Profit
Financial Operating Cycle
Efficiency
CashProfit

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What is Profitability?
How do we measure it?
Is how successful the business is.
Evaluation of the Income Statement
Comparison of results
Evaluate against benchmarks

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The roadtoimprove
profits

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Profitability Ratios
Measure the income or operating success of an
enterprise for a given period of time
WHO CARES? Everybody
WHY? A companys income affects:
its ability to obtain debt and equity financing
its liquidity positionits ability to grow

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These ratios measure the operatingefficiency of the firm and its ability to ensure
adequate returns to its shareholders.The profitability of a firm can be measuredby its profitability ratios.
Further the profitability ratios can bedetermined :
(i) in relation to sales and(ii) in relation to investments

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Profitability ratios
Profitability ratios in relation to sales:
gross profit margin
Net profit margin Expenses ratio

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Gross profit margin
A firm should have a reasonable grossprofit margin to ensure coverage of itsoperating expenses and ensure adequate
return to the owners of the business ie. theshareholders.
To judge whether the ratio is satisfactory
or not, it should be compared with thefirms past ratios or with the ratio of similarfirms in the same industry or with the
industry average.

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Gross Profit Margin
The percentage that a company makes onselling products after taking into accountthe direct costs of that sale. This is the
Gross Profit as a percentage of Sales.
Th I t f G P fit f

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The Importance of Gross Profit fora Higher Margin Business: The
Virtuous CycleGross Profit
Marketing & SalesAdministrationCustomer ServiceR & DPURCHASING
High grossmargin enablescompany tospend largeamounts for R&D,advertising,customer serviceetc.
Spending onR&D etc.enablecompany tochargepremiumprices, therebysupporting thehigher grossmargin

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Net profit margin
Another variant of net profit margin isoperating profit margin which is calculatedas:
Operating profit margin =
net profit before interest and tax x100
Net sales
Higher the ratio, greater is the capacity ofthe firm to withstand adverse economicconditions and vice versa

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Expenses ratioThese ratios are calculated by dividing the variousexpenses by sales. The variants of expenses ratios are:
Material consumed ratio = Material consumed x 100Net sales
Manufacturing expenses ratio = manufacturingexpenses x 100
Net salesAdministration expenses ratio = administration expensesx 100
Net salesSelling expenses ratio = Selling expenses x 100
Net salesOperating ratio = cost of goods sold plus operatingexpenses x 100
Net salesFinancial expense ratio = financial expenses x 100
Net sales

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Expenses ratio
The expenses ratios should be comparedover a period of time with the industryaverage as well as with the ratios of firms
of similar type. A low expenses ratio isfavourable.
The implication of a high ratio is that only a
small percentage share of sales isavailable for meeting financial liabilitieslike interest, tax, dividend etc.

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Profitability ratios
Profitability ratios in relation to investments
Return on assets (ROA)
Return on capital employed (ROCE)
Return on shareholders equity (ROE)
Earnings per share (EPS)
Dividend per share (DPS)
Dividend payout ratio (D/P)
Price earning ratio (P/E)

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Return on assets (ROA)
This ratio measures the profitability of the totalfunds of a firm. It measures the relationshipbetween net profits and total assets. The objectiveis to find out how efficiently the total assets have
been used by the management.Return on assets =
net profit after taxes plus interest x100
Total assetsTotal assets exclude fictitious assets. As the totalassets at the beginning of the year and end of theyear may not be the same, average total assetsmay be used as the denominator.

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Return on shareholders equity
This ratio measures the relationship ofprofits to owners funds. Shareholders fallinto two groups i.e. preference shareholdersand equity shareholders. So the variants of
return on shareholders equity are
Return on total shareholders equity =net profits after taxes x
100Total shareholders equity
.

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TOTAL SHAREHOLDERS EQUITYincludes preference share capital plusequity share capital plus reserves and
surplus less accumulated losses andfictitious assets. To have a fairrepresentation of the total shareholders
funds, average total shareholders fundsmay be used as the denominator

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Return on ordinary shareholders equity =
net profit after taxes pref. dividend x100 Ordinary shareholdersequity or net worth
ORDINARY SHAREHOLDERS EQUITY ORNET WORTH includes equity share capitalplus reserves and surplus minus fictitiousassets.

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Capital employed
Assets Financing
Fixed assetsEquity
Net working capitalLT Debt
Current assetsCurrent liabilities
Capitalemployed
Capitalemployed

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Debt500
Equity500
ROA and ROE:A Simple Illustration
Liabilities+ Equity Revenue 2000
(COGS)
(Expenses)
(Interest)
(Taxes)
Net Profit 100
1000
Assets
ROA = 10%
ROE = 20%
1,900

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Debt
667
Equity
333
ROA and ROE The Impact ofIncreased Leverage
Liabilities+ Equity Revenue 2000
(COGS)
(Expenses)
(Interest)
(Taxes)
Net Profit 100
1000
Assets
ROA = 10%ROE = 30%

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Key Factors Affecting Profit Margin
and Asset Turnover
Return onEquity
Pricing
Costs
Expenses
Product
Mix
Profit
Margin Return onAssets
Asset
Turnover
Inventory &
ReceivableManagement
Fixed Asset
Management
(leverage)

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Return on capital employed
(ROCE)
This ratio measures the relationship between net profit andcapital employed. It indicates how efficiently the longtermfunds of owners and creditors are being used.
Return on capital employed =
net profit after taxes plus interestx 100
Capital employed
CAPITAL EMPLOYED denotes shareholders funds and
longterm borrowings.To have a fair representation of the capital employed,average capital employed may be used as thedenominator.

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Earnings per share (EPS)
This ratio measures the profit available tothe equity shareholders on a per sharebasis. This ratio is calculated by dividing net
profit available to equity shareholders by thenumber of equity shares.
Earnings per share =
net profit after tax preferencedividend
Number of equity shares

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Dividend per share (DPS)
This ratio shows the dividend paid to theshareholder on a per share basis. This is abetter indicator than the EPS as it shows the
amount of dividend received by the ordinaryshareholders, while EPS merely showstheoretically how much belongs to theordinary shareholders
Dividend per share =
Dividend paid to ordinaryshareholders
Number of equity shares

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Dividend payout ratio (D/P)
This ratio measures the relationship between theearnings belonging to the ordinary shareholdersand the dividend paid to them.
Dividend pay out ratio =total dividend paid to ordinary shareholders x
100
Net profit after taxpreference dividendOR
Dividend pay out ratio = Dividend per share x100
Earnings per share

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Price earning ratio (P/E)
This ratio is computed by dividing the marketprice of the shares by the earnings pershare. It measures the expectations of the
investors and market appraisal of theperformance of the firm.
Price earning ratio = market price per share
Earnings per share