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Profitability Ratio Analysis & Example 

List of profitability ratios and formulas:

1) Gross Profit ratio = (Gross profit / Net sales) * 100 %

2) Net Profit ratio = (Net profit / Net sales) * 100 %

3) Operating profit margin = Operating income / Net sales

4) Return on Capital Employed = (Profit before interest / Capital employed) * 100 %

5) Return on Equity (ROE) = Net income / Average shareholders equity

6) Return on Assets (ROA) = Net income / Total assets

7) Cash flow return on investment (CFROI) = Cash flow / Market recapitalisation

8) Risk adjusted return on capital (RAROC) = Expected return / Economic capital

9) Return on net assets = Net income / Net assets

Example:

Calculate the profitability ratios, given the following figures:

Stock at the start of the year: Rs.10,000

Stock at the end of the year: Rs.6,000

Sales: Rs.18,000

Sales returns: Rs.3,000

Purchases: Rs.2,000

Overhead expenses: Rs.3,000

Capital at start of year: Rs.17,000

Capital at end of year: Rs.15,000

Solution:

Net sales = Rs.18,000 - Rs.3,000 = Rs.15,000

Cost of sales = Stock at start + purchases - Stock at end = 10,000 + 2,000 - 6,000 = Rs.6,000

Gross profit = Net sales - Cost of sales = Rs.15,000 - Rs.6,000 = Rs.11,000

Gross profit ratio = (11,000 / 15,000 ) * 100% = 73.33 %

Net profit = Gross profit - overhead expenses = 11,000 - 3,000 = Rs.8,000

Net profit ratio = (8,000 / 15,000 ) * 100% = 53.33 %

Average capital employed = 1/2 (Capital at start + Capital at end) = 1/2 (17,000+15,000) = Rs.16,000

ROCE = ( 8,000 / 16,000) * 100% = 50%

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Investment Ratio Analysis & Example 

List of investment ratios and formulas:

1) Dividend cover = Profit after tax / dividends

2) Dividend yield = ( Dividend per share/ Market price per share ) * 100 %

3) Earnings per share (EPS) = Profit available to equity shareholders / Number of equity shares

4) Price earnings ratio (P/E) = Market price per share / Earnings per share

5) Price to sales ratio = Market price per share / Sales per share

6) Price earnings growth (PEG) ratio = Price per earnings / Annual EPS growth

7) Price to book value (PBV) = Market price per share / Balance sheet price per share

8) Payout Ratio = Dividend per share / EPS

Examples:

1) Camry Ltd made a net profit of Rs.80,000 that is available to ordinary shareholders, and the dividend declared

is Rs.20,000, then:

Dividend cover = 80,000 / 20,000 = 4 times

2) An investor bought a share at Rs.6.00 and he received a dividend of Rs.0.30 on it, then:

Dividend yield = (0.30 / 6.00) * 100 % = 5 %

3) Company ABC has an annual earning of Rs.140,000 dollars. Total dividends of Rs.70,000 are to be paid out, and

the company has 350,000 outstanding shares.

Solution:

Earnings per share (EPS) = Rs.140,000 / 350,000 = Rs.0.40

Dividend per share = 70,000 / 350,000 = Rs.0.20

The dividend payout ratio = 0.20 / 0.40 = 50%

4) Sports Ltd has ordinary share capital of 200,000 shares at Rs.1 each. It made a net profit of Rs.400,000 that is

available to the ordinary shareholders. The market price of a share is Rs.6.00.

Then:

EPS = Rs.400,000 / 200,000 = Rs.2 per share

P/E ratio = Rs.6 / Rs.2 = 3

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Financial Leverage Ratio Analysis 

Definition: Financial Leverage Ratio (also called long-term solvency ratio) is used to measure the firm's ability to

repay its long-term debts. It gives an indication of the long-term solvency of the firm.

Formula:

1) Debt to Equity = Total Debt / Total Equity

2) Total Debts to Assets = Total Liabilities / Total Assets

3) Interest Coverage Ratio = Earnings Before Interest and Taxes / Interest Charges

4) Debt service coverage ratio = Net Operating Income / Total Debt Service

5) Capitalization Ratio = Long-term Debt / (Long-term debt + Shareholder equity)

Example 1:

CK Ltd has total liabilities of Rs.700,000 and total stockholders’ equity of Rs.380,000, then the debt/capital ratio is:

700,000 / (700,000 + 380,000) = 700,000 / 1,080,000 = 0.6481 = 64.81%

Example 2:

Saint Ltd. is looking at an investment property with a net operating income of Rs.87,000 and an annual debt

service of Rs.58,000. The debt service coverage ratio for this property = 87,000 / 58,000 = 1.5

Example 3:

Jimmy plc has total sales revenue of Rs.99,000 for the year. It has cost sales Rs.9,000 and operating expenses of

Rs.5,000. The company’s interest expense for the year is Rs.25,000.

Then,

Earnings Before Interest and Taxes = Sales – Cost of sales – Operating expenses

EBIT = Rs.99,000 - Rs.9,000 - Rs.5,000

EBIT = Rs.85,000

Interest Coverage Ratio = Rs.85,000/Rs.25,000 = 3.4 times

Example 4:

Peters Ltd has the following information:

Creditors Rs.2,000

Loan Rs.38,000

Buildings Rs.60,500

Debtors Rs.7,000

Bank Rs.5,000

Stocks Rs.4,500

Then, the Total Liabilities = 2,000 + 38,000 = Rs.40,000

Total Assets = 60,500 + 7,000 + 5,000 + 4,500 = Rs.77,000

Total Debts to Assets = 40,000 / 77,000 = 0.519

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Efficiency Ratio Analysis & Example 

Definition: Efficiency Ratios (also known as Activity ratios) are used to measure the effectiveness of the firm's use

of resources.

Formula:

1) Average Collection Period = (Average Trade Debtors / Credit Sales) * No. of Days

2) Average Payment Period = (Average Trade Creditors / Credit Purchases) * No. of Days

3) Inventory Turnover Ratio = Cost of goods sold / Average inventory held

4) Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors

5) Total Assets Turnover = Net Sales / Total Assets

6) Degree of Operating Leverage = % change in EBIT / % change in Sales

7) Creditors Turnover Ratio = Net Credit Purchases / Average Payable

8) Days Sales Outstanding Ratio = Accounts Receivable / Average sales per day

9) Working capital turnover Ratio = Cost of sales / Average net working capital

10) Current Asset Turnover Ratio = Cost of goods sold / Current assets

11) Stock Turnover Period = (Average stock / Cost of goods sold) * No. of Days

12) Cash Cycle = Stock Turnover Period + Average Collection Period - Average Payment Period

Example:

Emily Ltd has the following information:

Trade debtors Rs.100,000

Trade creditors Rs.80,000

Credit sales Rs.300,000

Credit purchases Rs.120,00

Cost of sales Rs.70,000

Opening stock Rs.60,000

Closing stock Rs.20,000

Bank Rs.66,000

Calculate the relevant Efficiency Ratios.

Solution:

Average Collection Period = (100,000 / 300,000) * 365 = 121.7 days

Average Payment Period = (80,000 / 120,000) * 365 = 243.3 days

Current Asset Turnover = 70,000 / (100,000 + 20,000 + 66,000) = 0.38

Average stock = (60,000 + 20,000) / 2 = Rs.40,000

Stock Turnover Period = (40,000 / 70,000) * 365 = 208.6 days

Cash Cycle = 208.6 + 121.7 - 243.3 = 87 days

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Liquidity Ratio Analysis & Example 

Definition: Liquidity ratios provide a general estimate of solvency of a company.

List of common liquidity ratios and formulas:

1) Current ratio (also known as working capital ratio)

= Current Assets / Current Liabilities

2) Quick ratio, in times (also known as acid test ratio or quick assets ratio)

= (Current Assets - Stock) / Current Liabilities

3) Interest Coverage = Profit Before Tax / Interest Charge

4) Gearing ratio = Long Term Liabilities / Equity Shareholders' Funds

5) Cash Ratio = Cash / Current Liabilities

6) Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

Example:

Calculate the working capital, acid test and gearing ratios, given the following figures:

Debtors: Rs.2,000

Creditors: Rs.5,000

Bank: Rs.11,000

Cash: Rs.1,000

Closing stock: Rs.6,000

Opening stock: Rs.7,000

Total Capital and Reserves: Rs.25,000

Long term loan: Rs.15,000

Solution:

Current assets = debtors + bank + cash + closing stock = 2000 + 11000 + 1000 + 6000 = Rs.20,000

Working capital ratio = 20,000 / 5,000 = 4 (This means that current assets are 4 times current liabilities)

Acid test ratio = (20,000 - 6,000) / 5,000 = 2.8 (This means that current assets in liquid form are 2.8 times

current liabilities)

Equity Shareholders' Funds = Total Capital and Reserves + Long term Liabilities = 25000 + 15000 = Rs.40,000

Gearing ratio = 15,000 / 40,000 = 0.375

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