Accounting - Key ratios - profitability
Key ratios - profitability
The key ratios used in the previous course are repeated here. Several
ratios have been added and are indicated by an asterisk.
Profitability is the measure of profit against sales, assets, capital or
1. Return on assets
*Return on owner's investment (ROI)
Net profit/average owners equity
This ratio shows the return to the owner on funds invested in the
business. Allowing for the extent of funds borrowed this ratio may differ
from return on assets.
Return on assets (ROA)
Net profit/average total asset NP/TA
This ratio reflects the return on the total assets used in the business.
The average of total assets at the beginning of the period and at the end
is used in case there is a significant change in assets.
2. Return on sales
Gross profit ratio
Reflects the difference between the selling price of the stock and the
cost price. This may be described as the mark up on stock.
NET PROFIT RATIO
Measures net profit against sales. It reflects total revenue against all
costs and expenses incurred by the business. When used in conjunction with
the Gross profit ratio a business is able to discern whether the new
situation is due to change in trading or operating.
*3. Expense ratios
An example is 'selling expenses to sales'. The business may seek to
measure other major classifications of expenses against sales.
These ratios are particularly useful when engaged in trend analysis. The
responsiveness of an expense category such as selling expenses to sales
indicates the effectiveness in the use of those expenses to generate
revenue for the business.
4. Asset turnover
Displays the revenue generated by assets. It shows how well the business
is using its assets. The carrying of excess stock, debtors or bank will be
reflected by a decline in the ratio.