Profitability Ratios
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| Profitability Ratios |
Profitability means the returns achieved through the efforts of
management on the funds invested by the owners of the business. Profitability
is the key interest of the owner of a business. Profitability ratios measure
managements. The following are the important profitability ratios:
Gross Profit Ratio
Gross Profit Ratio
Meaning
of gross profit ratio: This is the ratio between gross profit and net sales.
The gross profit is the different between net sales and cost of goods sold
(i.e., the direct cost of sales). A net sale means total sales less returns. This ratio is expressed as
a percentage of sales.
Formula of Gross Profit Ratio = Gross Profit/Net Sales * 100
Significance
of gross profit ratio
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| Significance of Gross Profit Ratio |
The more the gross profit earned the better. This is
because from the gross profit the company must cover its operating and other
expenses – what is left after that will be the net profit. It measures the
efficiency production / purchase as well as pricing.
Prices are often fixed so as to give a standard gross profit percentage,
so a fluctuation in the gross profit as a percentage of sales can indicates
errors or fraud affecting the sales, purchase or stock figures. This ratio is
thus used a lot by those especially with errors are fraud – management,
auditors and tax authorities.
Net Profit Ratio
Net Profit Ratio
Meaning
of net profit ratio-: This is the ratio between net profit and net sales.
Net profit is the excess of total sales of a given accounting period over total
expenses. This ratio seeks to assess the profitability of sales.
Formula of Net Profit Ratio = Net Profit/Net Sales * 100
Significance of net profit ratio
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| Significance of Net Profit Ratio |
A good net profit margin indicates management’s
ability to operate the business with sufficient success not only to cover the
cost of production, the operating expenses including depreciation, and the debt
service costs, but also to leave a margin of reasonable compensation to the
owners – who have provided funds to the business at a risk.
Operating Ratio
Operating Ratio
Meaning
of operating ratio-: This is the ratio between ‘cost of goods sold plus operating expenses’ and net sales.
It measures the proportion of operating expenses per rupee of sales. It is
expressed as a percentage of sales.
Cost of Goods Sold = Sales less
Gross Profit
OR
= Operating Stock + Purchase + Direct Expenses + Wages – Closing Stock
Operating Expenses = Administration Expenses + Selling and Distribution
Expenses
Formula of Operating Ratio = Cost of Goods Sold + Operating Expenses/Net
Sales * 100
Significance
of operating ratio
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| Significance of Operating Ratio |
A high operating ratio indicates a small surplus
available to the business and, in effect, a lower profitability. The lower the
ratio, the greater the ability to carry a large burden of fixed overheads.
Operating Profit Ratio
Operating Profit Ratio
Meaning
of operating profit ratio-: It is the relationship between operating ratio
and sales. Operating profit is calculated after deducting operating expenses
from gross profit. No non-operation profit such as dividend / interest from
investments is taken into consideration.
Formula of Operating Profit Ratio = Gross Profit – Operating
Expenses/Sales * 100
Significance
of operating profit ratio
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| Significance of Operating Profit Ratio |
It indicates the earning capacity of the firm
from operation, i.e., core business activity.
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