Profitability Ratios

• What are profitability ratios used for?

  To assess the performance of a business
• Why are profitability ratios important for businesses?

  They indicate returns for risks taken
• What is profit considered in business?

  It is a return on investment
• How is total profit calculated?

  Total sales minus total costs
• What happens if costs are greater than sales?

  A loss is incurred
• Why measure profit in relative terms?

  To understand profit as a proportion of revenue
• From where do we obtain information for profitability ratios?

  Income statement and balance sheet
• What are the four key profitability ratios?

  • Gross profit margin
  • Operating profit margin
  • Net profit margin
  • Return on capital employed (RCE)
• How is gross profit margin calculated?

  Gross profit divided by total sales revenue
• What is the formula for operating profit margin?

  Operating profit divided by sales revenue
• How do you calculate net profit margin?

  Net profit divided by sales revenue
• What does return on capital employed compare?

  Profit earned to the amount invested
• What are the steps to calculate gross profit margin?

  1. Calculate gross profit: Sales - Cost of sales
  2. Divide gross profit by total sales revenue
  3. Multiply by 100 to get percentage
• What are the steps to calculate operating profit margin?

  1. Calculate operating profit: Gross profit - Overheads
  2. Divide operating profit by sales revenue
  3. Multiply by 100 to get percentage
• What are the steps to calculate net profit margin?

  1. Identify net profit for the year
  2. Divide net profit by sales revenue
  3. Multiply by 100 to get percentage
• What are the steps to calculate return on capital employed?

  1. Identify operating profit
  2. Divide operating profit by capital employed
  3. Multiply by 100 to get percentage