Profitability And

Turnover Ratio

Introduction

Profitability ratios compare income statement accounts and categories to show a company's ability to generate profits from its operations. Profitability ratios focus on a company's return on investment in inventory and other assets. These ratios basically shows how well companies can achieve profits from their operations.

......Investors and creditors can use it to judge a company's return on investment based on its relative level of resources and assets.it can be used to judge whether companies are making enough operational profit from their assets.it relate to efficiency ratios because they show how well companies are using their assets to generate profits.

Definitions“The ratios that measure the capacity of a firm to generate profits out of the expenses and the other cost incurred over a period are called the profitability ratios”.

“The Profitability Ratios measure the overall performance of the company in terms of the total revenue generated from its operations”.

Types of Profitability Ratio

Gross profit RatioOperating profit RatioNet profit RatioReturn on Assets Return on EquityReturn on capital employed

Gross profit Ratio

The gross profit ratio looks at cost of goods sold as a percentage of sales. This ratio looks at how well a company controls the cost of its inventory and the manufacturing of its products and subsequently pass on the costs to its customers. The larger the gross profit ratio the better for the company.

Benefits

Gross ratio measures a company's manufacturing and distribution efficiency during the production process. Investors use the gross profit ratio to compare companies in the same industry and also in different industries to determine what are the most profitable.A company that boasts a higher gross ratio than its competitors and industry is more efficient.

Formulagross profit = net revenue from operations

- direct expenses cost of material consumed

purchses+o.s.-cl.s.+ direct wages+ carriage inward

Gross profit ratio = Gross profit *100 sales

Net profit Ratio

Net profit Ratio is the percentage

of revenue remaining after all operating

expenses, interest, taxes and have been

deducted from a company's total revenue. 

that shows relationship between net profit

after tax and net sales.

......Total revenue-total expenses (Net Profit)*100

salesIt shows how good a company is at converting revenue into profits available for shareholders. Net profit ratio is often used to compare companies within the same industry.

Using the formula and the information above, we can calculate that Company XYZ's net profit ratio was

30,000/100,000*100 = 30%

Income statement of company XYZ for the year ended 2015Total revenue

₹100000

- Cost of goods sold

₹20000

Gross profit ₹80000

-operating expanses salaries ₹10000 rent ₹10000 utilities ₹5000 depreciation

₹5000 ₹30000

Interest expanses

₹10000

Tax ₹10000 ₹20000

Net profit ₹30000

Operating Profit Ratio

Operating ratio is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials.it is earnings before interest and taxes. It is a measure of overall operating efficiency, incorporating all of the expenses of ordinary, daily business activity.

Operating profit= Net sales - (Cost of goods sold + Administrative and office expenses + Selling and distribution exp.)

Operating ratio = Operating Income*100Net Sales

Benefits

operating ratio may be used to investigate a particular project or compare multiple projects within a company.a higher operating profit margin is desirable as it suggests greater potential to derive profits and more cushion against any increase in competition or costs.

Return on Assets

Return on assets is an indicator of how profitable a company is relative to its total assets. it gives an idea as to how efficient management is at using its assets to generate earnings. It display as a percentage. Sometimes this is called as return on investment.

.....Return on Assets = Net income*100

Total assets

ROA tells you what earnings were generated from invested capital (assets).

it gives investors an idea of how effectively the company is converting the money it has to invest into net income.

Return on Equity

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

.....

Return on Equity = Net IncomeShareholder's fund

It shows that the company is doing a good job using the investors' money.ROE is also and indicator of how effective management is at using equity financing to fund operations and grow the company.

Return on capital Employed ratio

Return on capital employed is a profitability

ratio that measures how efficiently a

company can generate profits from its

capital employed by comparing net

operating profit to capital employed.

......ROCE = Net Profit

Capital employed• it shows how effectively assets are

performing while taking into consideration long-term financing. 

• to evaluate the longevity of a company.• It also shows that how efficiently a

company uses its capital employed as well as its long-term financing strategies.

Turn Over (activity) Ratio

The turnover ratio is the percentage of a mutual fund or other investment's holdings that have been replaced in a given year, which varies by the type of mutual fund, its investment objective and/or the portfolio manager's investing style.Turnover ratio is a measure of how a fund's portfolio changes in a year. This ratio indicates how much a fund is trading. 

Benefits

It helps an investor determine the fund’s expected performance in the future.A high turnover results in increased costs for the fund and decreased returns for shareholders due to shareholders paying spreads and commissions when buying and selling stocks.

Types of Turn over Ratios

1. Inventory turnover ratio2. Debtors turnover ratio3. Creditors turnover ratio4. Fixed asset turnover ratio5. Current assets turnover ratio6. Capital employed turnover ratio

Inventory turnover Ratio

Inventory turnover ratio is also known as stock turnover ratioInventory turnover ratio shows the relationship between the cost of good sold and the average inventory.Inventory turnover is a ratio showing how many times a company's inventory is sold and replaced over a period of time.

Inventory turnover ratio = cost of goods soldaverage stock

•  Cost Of Good Sold = Opening stock+ Purchases+Carriage inward+Direct wages and expenses- Closing Stock

• Cost Of Good Sold =Sales - Gross profit• Average stock = (Opening stock + closing stock)/2

A higher ratio would indicate that company is able to sell its products quickly.

a lower ratio would imply that has not been efficient in its work.

Debtors turnover ratio

Debtors turnover ratio is also called receivable turnover ratio.

 It measures how effectively the company is collecting the cash from its creditors for goods sold on credit by the company.

Debtors Turnover Ratio = Net credit salesaverage account

receivable *account receivable includes 'trade debtors and

bills receivable'.

A high ratio would indicate that company is able to collect cash from its creditors quickly.

low ratio would imply that company needs some work as far as collection department is concerned.

Creditors turnover ratio

It is also called account payable turnover ratioIt measures how quickly the company pays its creditors for goods purchased by the company on credit. 

creditors turnover Net credit purchase ratio = average creditors

Account payable = trade creditors + bills payable

 A high ratio would indicate that company is paying its creditors quickly

while a lower ratio would imply that company is not able to pay creditors on time which in turn will indicate worsening financial position of the company.

Fixed assets turnover ratio

It is also termed as the ratio of sales to fixed assets.It indicates how efficiently the fixed assets are used.It measures the efficiency with which the firm has been using its fixed assets to generate sales.

Fixed Assets = Net salesTurnover ratio gross fixed asset –depreciation

A higher ratio would imply that company is using fixed asset to generate more sales.

while a lower ratio would imply that company has been inefficient in using the fixed assets.

Current asset turnover ratio

It signifies the total sales done by the company with an investment in the current asset.Current assets turnover ratio shows the relationship between net sales and current assets.

Current asset turnover ratio = net sales current asset

 A higher ratio implies that company has been successful in utilizing the current assets; current assets include cash, stocks, debtors, prepaid expense and so on.

Capital employed turnover ratio

It shows how efficiently the sales are generated from the capital employed by the firm.It helps the investors or the creditors to determine the ability of a firm to generate revenues from the capital employed and act as a key decision factor for lending more money to the asking firm.

Capital employed = Net salesturn over ratio capital employed

Where, Capital Employed = Net worth + Long-term Borrowings

Net Worth = Share Capital + All Reserves

Higher the ratio better is the utilization of capital employed and shows the ability of the firm to generate maximum profits with the minimum amount of capital employed.