Analysis3[1] - PROFITABILITY RATIOS These ratios are based on the premise that a firm should earn sufficient profit not only on turnover but also

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Unformatted text preview: PROFITABILITY RATIOS These ratios are based on the premise that a firm should earn sufficient profit not only on turnover but also for shareholders. If the profit is inadequate, then the operating expenses can not be recovered so also dividend can not be paid to owners . Generally the ratios under this head are broadly classified under two heads: 1) Profit ratios based on Turnover 2) Profit ratios based on Investment 1) Profit Ratios Based on Turnover : The various ratios under this category are as follows: A) Gross Profit Ratio B) Net Profit Ratio C) Operating Ratio D) Expenses Ratio E) Operating Profit Ratio A) Gross Profit Ratio : Gross Profit Gross Profit Ratio = ---------------------------- X 100 Net Sales Gross Profit = Net Sales -- Cost of Goods Sold General Interpretation : - Gross profit depends on prices, sales volume and costs. Any change in these factors affects gross profit.- A high gross profit ratio is a sign of good management and it also gives an idea as to how far the operating and non-operating expenses can be tolerated.- A low gross profit ratio may point towards danger signals like a higher cost of production, lower selling price and many more . B) Net Profit Ratio : Net Profit after tax Net Profit Ratio = ------------------------------------ X 100 Net Sales General Interpretation :- A high net profit ratio is a good sign as it ensures sufficient return to owners, more coverage for additional expenses , etc.- A low net profit ratio gives a bad sign but the company may earn more profit by selling more quantities. Pricing in a competitive market is guided by this phenomenon .- The gross profit ratio and net profit ratio should be jointly studied to arrive at a right conclusion. Because both may show different trends .- The overall rate of return on investment can be calculated by multiplying the net profit ratio (%) with investment turnover ratio. C)Operating Ratio : Cost of goods sold + operating expenses Operating Ratio = ----------------------------------------- X100 Net Sales Operating expenses: Indirect operating expenses taken to P/L = Office & administration + Selling & Dist.exp. D) Expenses Ratio...
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This note was uploaded on 11/15/2011 for the course ACCOUNTS 231 taught by Professor Majidkhan during the Winter '11 term at IIPM.

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Analysis3[1] - PROFITABILITY RATIOS These ratios are based on the premise that a firm should earn sufficient profit not only on turnover but also

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