Profitability ratios are key tools for assessing a company's financial health. They measure how effectively a business turns sales into profits, using metrics like profit margins and return ratios. These ratios help investors and managers gauge a company's efficiency in generating income from its operations.
The DuPont analysis takes a deeper dive into return on equity (ROE). By breaking ROE into profit margin, asset turnover, and financial leverage components, it reveals the underlying drivers of a company's profitability. This method helps pinpoint areas for improvement in a firm's financial performance.
Profitability Ratios
Profit margin calculation and interpretation
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Measures percentage of each sales dollar resulting in profit
Net income divided by sales: Profit Margin=SalesNet Income
Higher margins indicate greater profitability and efficiency (Apple, Coca-Cola)
Gross profit margin focuses on gross profit relative to sales
Gross profit divided by sales: Gross Profit Margin=SalesGross Profit
Percentage of each sales dollar remaining after cost of goods sold (retail, manufacturing)
Operating profit margin considers operating income relative to sales
Operating income divided by sales: Operating Profit Margin=SalesOperating Income
Percentage of each sales dollar left after cost of goods sold and operating expenses (utilities, rent)
Can be calculated using earnings before interest and taxes (EBIT) for a more comprehensive view
Net profit margin most comprehensive, considering net income relative to sales
Net income divided by sales: Net Profit Margin=SalesNet Income
Percentage of each sales dollar remaining as profit after all expenses and income (Amazon, ExxonMobil)
Return ratios for financial efficiency
Return on total assets (ROA) measures efficiency of assets in generating profits
Net income divided by average total assets: ROA=Average Total AssetsNet Income
Higher ROA indicates more efficient asset utilization (Walmart, McDonald's)
Return on equity (ROE) measures return generated on shareholders' equity
Net income divided by average shareholders' equity: ROE=Average Shareholders’ EquityNet Income