PROFITABILITY RATIO

- Comes from two words which are profit and ability.

- Refers to the company’s ability to generate earnings. It is one of the most important
goals of business.
a. earning profit is a way for a business to survive so that the business can pay
its current liabilities

- Measures the results of business preparations or overall performance and

effectiveness of the firm.
a. When we say results of business operations, it means the business will either
earn a profit or incurred of loses

TYPES OF PROFITABILITY OF RATIO

1. Return on Equity (ROE)
2. Return on Asset (ROA)
3. Gross Profit Margin
4. Operating Profit Margin
5. Net Profit Margin

1. RETURN ON EQUITY (ROE) - also referred as Return on Net Worth

- Measures the amount of net income earned in relation to stockholder’s equity.
- Measures the rate of return that the owners of common stock of a company receive
on their shareholdings
a. Magkano yung bumabalik sa mga capital na ini-invest sa business

- Signifies how good the company is in generating returns on the investment it

received from its shareholders.

FORMULA

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
RETURN ON EQUITY(ROE) = Shareholder’s Equity

RETURN ON AVERAGE EQUITY = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

(ROAE) Average Shareholder’s Equity

Note: The formulas are the same but we will use it depending on the problem given. If isa ra
ka year ang gihatag then we will use the ROE formula pero if gihatag kay example 2 ka year,
ang tawag ana na financial statement is Comparative Financial Statement.

Note: IF MAG COMPUTE TA UG ROE, DAPAT 15-20% ANG ATOANG MAKUHA. PERO
THE HIGHER THE ROE, MUCH BETTER.
SAMPLE PROBLEM:

(since isa ra ka year ang gihatag, we’ll use the ROE)

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
RETURN ON EQUITY(ROE) = Shareholder’s Equity

If net income ang gipangita, usually makita ni siya income statement. While ang
shareholder’s equity, makita siya sa balance sheet.

If duha ang net income like Net income before Tax and Net Income after Tax, ang gamiton is
ang Net Income after Tax.

If di makita ang shareholder’s equity, pangitaa ang stockholder’s equity, same rana.

QUESTION: WHAT IS THE RETURN ON EQUITY (ROE)?

SOLUTION: = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

Shareholder’s Equity

= 352,240
2,075,000

= 0.16975 or 0.1698 (16.98%)

0.16:1 meaning sa kada 1 na investment sa capital o business, naay return na 16 centavos

or equivalent to 16.98%.

Is it a good ratio or bad ratio? - since naa man sa between sa 15-20% then it is a good ratio.
Since duha man ka year ang gihatag sa balance sheet, we will use the ROEA.

RETURN ON AVERAGE EQUITY = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

(ROAE) Average Shareholder’s Equity

When we say Average Shareholder’s Equity, i add ang duha ka stockholder’s equity or
kanang shareholder’s equity then divide sa 2 para ma average.

Average Shareholder’s Equity

219,000 + 231,500
= 2

= P 225,250

GIVEN:
NET INCOME - 12,500
AVERAGE SHAREHOLDERS EQUITY - 225,250

12,500
= 225,250

= 0.0554 or 0.055 (5.55%)

0.05:1 , meaning sa kada piso na investment sa capital mo naa ray return 0.05 centavos.

Meaning it’s a bad ratio since wala siya kaabot ug 15-20% na goal para maingon na good.
Dili siya effective in utilising the capital ng business kaya mababa ang return.
2. RETURNS ON ASSETS (ROA)
- Measures the ability of a company to generate income out of its resources/asset
a. Unsay connect sa resources/assets in generating income? Meaning you use the
assets like equipment para makahimo ug products then i baligya.

- Refers to the financial ratio that assesses the ability of a company to effectively use
its assets to generate earnings.
- To put it simply, this metric is used to measure the ability of a company to convert its
investment in assets into profits.

FORMULA:

ROA = Net Income

Total Assets

ROA = Net Income

Average Total Assets

If isa ra ka year ang ginahatag na year then kanang walay average ang gamiton pero if
duha, kanang average ang gumption.

ROA of 5% or better is typically considered a good ration while 20% or better is considered
great. In general, the higher the ROA, the more efficient the company is at generating profits.

EXAMPLE:

= Net Income
Total Assets
= 352,240
4,900,000

= 0.07189 or 0.0719 (7.19%)

0.07:1, meaning sa kada 1 na asset or investment sa asset, ang return is 0.07 centavos.

Is it a good ratio? -since nalapas man siya sa 7%, it means its a good ratio.

ANOTHER EXAMPLE:

Since duha naman ka year ang gihatag, we’ll use ang naay average.

= Net Income
Average Total Assets

Since already given na ang net income, ang average total assets ang atong pangitaon.

I add ang total assets sa duha ka year then divide sa 2.

AVA= 427,500 + 421,500

2

= P 424,500

SOLUTION:

= 12,500
424,500
=0.02944 or 0.0294 or 2.94%

0.029:1, meaning sa kada 1 na gihatag nato sa assets, ang return is 0.029 centavos. It’s a
bad ratio since wala siya naka tungtung sa 5% na requirement para maingon na good ration.

3. GROSS PROFIT MARGIN RATIO

- Show how many pesos of gross profit is earned for every peso of sale.
- Provides information regarding the ability of a company to cover its manufacturing
cost from its sales.
- Means mao ni ang tabo nimo while namaligya ug products.
- Gross profit is just sales less the cost of goods or cost of services.

FORMULA:

As a rule of thumb, 5% is a low margin, 10% is a healthy margin and 20% is a high margin.
But Gross Profit Margin depends on what type of business it is.

Ang gross profit isa kanang gross margin (same rana sila)
= gross profit × 100
Net sales

= 700,000 × 100
2,000,000

= 0.35 or 35%

0.35:1, meaning sa kada 1 na nabebenta mo may tinutubo ka na 0.35 centavos. In totality,

sa 2,000,000 na kinita mo, may 35% ka na tinubo or P 7,000,000.

As a low of thumb, since nalapas man siya ug 20% meaning it is a high margin.

4. OPERATING PROFIT MARGIN RATIO

- Shows how many pesos of operating profit is earned for every peso of sale.
- It measures the percentage of operating income to sales
- measures the amount of income generated from the core business of a company.

Difference between the Gross Profit and the Operating Profit

- Gross Profit ang tawag is Tubo
- Operating Profit ito ang iyong income mo after i minus ang tanan operating expense
like rent or mga nagasto while imong gi baligya imong products
- High operating ratio may imply a lean operation and have a low operating expense.
- Maximizing operating income depends on keeping operating costs as low as
possible. (Horngreen et. al. 2013)

FORMULA:

For most businesses, an operating margin higher than 15% is considered good.
Operating Margin = Operating Profit × 100
Net Sales

= 501,000 × 100
2,000,000

= 0.2505 or 25.05%

0.25:1, meaning sa kada 1 na benta is naa pay mahabilin sa atong operating profit na 0.25
centavos. Kahit nabayran na ang expenses, naa pay nahibilin na 25 cents. Meaning sa 2
million na halin nimo sa pagtinda, naa pakay P500,000 na operating profit.

Since 25% man ang na achieved, meaning it is good kay dako kaayo ug operating profit.
basin gamay ra ang atoang operating expense or ang mga nagasto.

5. NET PROFIT MARGIN RATIO

- when we say net profit, we are talking about net income
- Measures how much net profit a comapny generates for every peso of sales or
revenues that it genrates
- Measures the percentage of net income to sales
- Provides an understanding of the percentage of sales, which is left after the company
has paid the expenses.
- Shows how much profit will to to the owner for every peso of sales made
Difference between gross profit, operating profit and net profit
- Gross profit ang tinubo sa pagbebenta
- Operating profit ang tubo after gi minus tanan operating expense. However dili pana
mao kay naa pakay other expenses na bayaran.
- After ma minusan imong operating profit sa other expenses, kwaan pana siya sa net
income and ang difference ana kay mao atong gitawag ug Net Income.

Net Income before Tax- tawag after gi minus and operating profit ug other expenses
Net Income After Tax- tawag after ma minusan ang Net Income before Tax sa Income Tax na
dapat bayran.

FORMULA:

Gnerally, a net profit margin in excess of 10% is considered excellent, though it depends on
the industry and the structure of the business.

(ang net income is kanang after mabayaran ang income tax or kanang Net Income after Tax)
= 352,240 × 100
2,000,000

=0.17612 or 17.61%

0.17:1, meaning sa kada 1 na naibebenta mo, ang mahibilin nalang is 17 centavos. Or sa

2M na imong natinda, ang mahibilin nalang is 17.61%.

Considered ba siya as an excellent ratio? Yes, kay nalapas man siya sa 10% even after
mabayaran tanan bayrunon.