Ratio Analysis Part 5 Profitability Ratios Paper 3B: Financial Management Chapter 3 Unit I CA B. Hari Gopal B.com, PGDBA, FCA, FCMA, DISA(ICAI), PMP (PMI, USA), EPBM (IIMC), MCT
2 Learning Objectives 1. Gain Knowledge on Profitability Ratios 2. Usage of various Profitability Ratios 3. Preparation of various Profitability Ratios
3 Introduction to Profitability Ratios Background Types of Profitability Ratios
4 Profitability Ratios - Background Profitability Ratios Meaning Categories
From Owner s Point of view 5
6 Profitability ratios required for analysis from Owner s point of view Required for analysis from Owner s point of view Return on Equity (DuPont Model) Earnings Per Share Dividend Per Share Price Earning Ratio
7 Return on Equity Measures the profitability of equity funds invested in the firm Formulae: Profit After Taxes/ Net Worth ROE is one of the most important indicators of a firm s profitability and potential growth
8 Return on Equity DuPont Model Components of DuPont Model Net Profit Margin Asset Turnover Equity Multiplier
9 DuPont Model Net Profit Margin Net profit margin is simply the after tax profit a company generates for each rupee of revenue Formulae: Net Income / Revenue Net profit margin is a safety cushion: Lower the margin, less room for error
10 DuPont Model Asset Turnover A Measure of how effectively a company converts its assets in to sales Formulae: Revenue / Assets Asset turnover ratio tends to be inversely related to the net profit margin.
11 DuPont Model Equity Multiplier It is possible for a company with good sales and margins to take excessive debt and artificially increase its return on equity Equity Multiplier is a measure Financial leverage, allows investor to see what portion of the return is the result of debt Formulae: Assets / Net Worth
12 Earning Per Share Measures the profitability of a firm in terms of earning per Equity share Formulae: Net Profit available to Equity Shareholders/ Number of Equity Shares outstanding
13 Dividend Per Share Indicates the amount of profit distributed to each equity share Formulae: Net Profit distributed to Equity Shareholders/ Number of Equity Shares outstanding
14 Price Earning Ratio Indicates the expectations of the equity investors about the earnings of the firm Formulae: Market Price per Share / Earnings per Share
Based on Assets / Investments 15
16 Based on Assets / Investments Return on Capital Employed (ROCE) / Return on Investment (ROI) Return on Assets (ROA)
17 Return on Capital Employed (ROCE) It is the percentage of return on funds invested in the business by its owners Formulae: NOPAT x 100 / Capital Employed NOPAT = EBIT (1-t) Non-operating Income Capital Employed = Total Assets Current Liabilities (or) Fixed Assets + Working Capital
18 Return on Capital Employed (ROCE) ROCE = Profitability Ratio x Capital Turnover Ratio Profitability Ratio = Return / Sales x 100 Capital Turnover Ratio = Sales / Capital Employed ROI can be improved either by improving operating profit or capital turnover or both
19 Return on Assets This ratio measures the profitability of the firm in terms of assets employed in it. Return on Assets = Net Profit After Taxes / Average Total Assets (or) Return on Assets = Net Profit After Taxes / Average Tangible Assets
Based on Sales 20
21 Profitability Ratio based on Sales Classified in to following ratios Gross Profit ratio Gross Profit x 100 / Sales Operating Profit ratio Operating Profit x 100 / Sales Net Profit ratio Net Profit x 100 / Sales
Based on Capital Market Info 22
23 Based on Capital Market Information Classified in to following ratios Price Earning Ratio = Average Share Price / EPS Yield = Dividend / Average Share Price Market Value / Book Value per share = Average Share Price / Book Value per share
24 Lesson Summary 1. We have learnt the meaning and categories of Profitability ratios 2. We had discussed various categories of Profitability ratios in detail (including DuPont Model) and their usage.
25 Testing time Profitability Ratios - Multiple Choice Questions
26 MCQ 1 Return on Equity measures the of Equity funds invested in the firm A. Activity B. Capital Structure C. Liquidity D. Profitability Answer: D. Profitability
27 MCQ 2 The profitability of a firm from the point of view of ordinary shareholders can be measured in terms of A. Earnings per share B. Dividend per share C. Return on Investment D. Gross Profit Ratio Answer : A. Earnings per share
28 MCQ 3 Following is excluded for calculation of Return on Capital Employed A. Intangible Assets B. Fixed Assets C. Fictitious Assets D. Current Assets Answer : C. Fictitious Assets
29 MCQ 4 ratio is used to compare the product profitability A. Net Profit B. Gross Profit C. Operating Profit D. Earnings per share Answer : B. Gross Profit
30 MCQ 5 indicates true return in which share capital is taken at its market value A. Earnings per share B. Yield C. Price Earning Ratio D. Net Profit Ratio Answer : B. Yield
What Next 31
32 Follow the below Presentations Ratio Analysis Part 1 Overview Ratio Analysis Part 2 - Liquidity Ratios Ratio Analysis Part 3 - Leverage Ratios Ratio Analysis Part 4 Activity Ratios
Thank You 33