Accounting Measures Profitability

& Firm Performance Ratios 1 / 2

Ratio Calculation
Gross Profit
Margin Sales–Cost of goods sold
Sales

Assesses firm profitability

Operating Profit before interest & taxes without regard to interest
Profit Margin Sales charges as a result of the
capital structure

Net Profit Profits after taxes After tax profits per dollar of
Margin Sales sales
(Return on Sales)

2-1
Accounting Measures Profitability
& Firm Performance Ratios 2 / 2
Ratio Calculation
Profit after taxes+interest Measures the return on the
total investment in the firm
Total assets

Profit after taxes (PAT) Rate of return to share-

Total shareholders’ equity holders given their
investment in the firm

Return on investment
common shareholders have
made in the firm

PAT–Preferred stock dividends # Earnings available to

common shares outstanding common shareholders
2-2
Accounting Measures Liquidity
& Firm Performance Ratios
Ratio Calculation
Ability to cover ST debt with
Current Assets
assets convertible to cash in the
Current Liabilities
period ST debt matures

Ability to pay off short-term

Current assets-Inventory debt without relying on
Current liabilities inventory

Measure to which firm’s

working capital is tied up
in inventory

*2-3
Accounting Measures
& Firm Performance
Ratio Calculation

Total debt Measures use of debt to

Total assets finance operations

Use of debt relative to

Total debt
shareholders’
Total shareholders equity
investment in firm

Balance between debt &

equity in long-term capital
structure of firm

2-4
Accounting Measures
& Firm Performance
Ratio Calculation
Profits before interest & taxes Measures how much profits
Total interest charges can decline before firm is
unable to meet its interest
obligations

Profits before interest & taxes + More inclusive measure of

Lease obligations ability of firm to handle all
Interest charges of fixed-charge
+ Lease obligations obligations

2-5
Accounting Measures Misc. Ratios -
& Firm Performance Shareholder Returns

Ratio Calculation

Annual dividends per share Measures return to common

Current market price per shareholders
share

Current market price per Market perception of firm

share Faster-growing / less risky firms
After-tax earnings per share tend to have higher P/E ratios

Annual dividends per share Indicates dividends paid

After-tax earnings per share out as a % of profits

2-6
Accounting Measures Miscellaneous
& Firm Performance Ratios

Ratio Calculation
After-tax profits
+depreciation Measures total cash per
# of common shares share available to firm
outstanding

Measures the number of

Fixed costs units that need to be sold to
Contribution margin begin to make a profit on
that product or service

Contribution margin = (Selling price/unit) – (variable price/unit)

2-7