Profitability ratios

What is profit?

the reward or return for taking risks and making investments

What are profitability ratios?

examines the companies profitability against given targets or in comparison

What are profit margins?

measures the percentage of sales which is left as profit after costs have been deducted

Why is profit margins useful?

it measures both the firms success in generating profit and their ability to control costs

What is the equation for profit?

total sales - total cost

What is ratio analysis?

analysing relationships between financial data to assess the performance of a business

What are the main profitability ratios?

net profit margin
gross profit margin
return on capital employed

What is the net profit margin?

it takes overheads into account

What is the equation for net profit margin?

net profit / revenue x 100

Is it better to have a high or low net profit margin?

high

What does it mean when a business has a declining profit margin?

they are having troubles with their overheads

How can a business improve their net profit margin?

raising revenue
lowering costs of sales or overheads

What is the gross profit margin?

measures the relationship between the gross profit and the value of sales

What is the equation for gross profit margin?

gross profit / revenue x 100

When can a business afford to have a low gross profit margin?

when they have a high asset turnover

How can a business improve their gross profit margin?

increasing prices
reducing the direct cost of sales
stopping selling products with a low gross profit margin

What is the equation for net profit?

gross profit - overheads

What is the equation for gross profit?

revenue - cost of sales

What is the return on capital employed?

it gives the percentage return on the capital invested in the business

What is the equation for return on capital employed?

operating profit / total equity + non-current liabilities

What does the return on capital employed tell you about the business?

how much money is made by the business compared to how much money's been put into the business

What is a decent return on capital employed percentage?

20% - 30%

What should you compare the return on capital employed to? Why?

with the Bank of England interest rate at the time because this tells investors whether they would be better off putting their money in the bank

How can a business improve their return on capital employed?

paying off debt to reduce non-current liabilities
by making the business more efficient to increase operating profit