The 

net profit margin

or simply net margin, measures how much net income or profit is generated as a percentage of revenue. It is the ratio of
net profits to revenues for a company or business segment.
Net profit margin is typically expressed as a percentage but can also be represented in decimal form. The net profit
margin illustrates how much of each dollar in revenue collected by a company translates into profit.

• Net profit margin measures how much net income is generated as a percentage of revenues received.

• Net profit margin helps investors assess if a company's management is generating enough profit from its sales
and whether operating costs and overhead costs are under control.
• Net profit margin is one of the most important indicators of a company's overall financial health.
• By tracking increases and decreases in its net profit margin, a company can assess whether current practices
are working and forecast profits based on revenues.

• Because companies express net profit margin as a percentage rather than a dollar amount, it is possible to
compare the profitability of two or more businesses regardless of size.

For example, a company can have growing revenue, but if its operating costs are increasing at a faster rate than revenue,
its net profit margin will shrink. Ideally, investors want to see a track record of expanding margins, meaning that the net
profit margin is rising over time.
Companies that can expand their net margins over time are generally rewarded with share price growth, as share price
growth is typically highly correlated with earnings growth.

Net profit Margin= Net Income (EAT) / Net sales

• On the income statement, subtract the cost of goods sold (COGS), operating expenses, other expenses, interest
(on debt), and taxes payable.

• Divide the result by revenue.

ASSET RATIOS

The asset turnover ratio measures the value of a company's sales or revenues relative to the value of its assets.
The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to
generate revenue.
The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets.
Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using its assets to
generate sales.

• Investors use the asset turnover ratio to compare similar companies in the same sector or group.

• A company's asset turnover ratio can be impacted by large asset sales as well as significant asset
purchases in a given year.
Asset Turnover = Net sales / Average total asset

The return on assets (ROA) refers to a financial ratio that indicates how profitable a company is in relation to its
total assets. Corporate management, analysts, and investors can use ROA to determine how efficiently a
company uses its assets to generate a profit.
The metric is commonly expressed as a percentage by using a company's net income and its average assets. A
higher ROA means a company is more efficient and productive at managing its balance sheet to generate
profits while a lower ROA indicates there is room for improvement.

Businesses are about efficiency. Comparing profits to revenue is a useful operational metric, but comparing
them to the resources a company used to earn them displays the feasibility of that company's existence. Return
on assets is the simplest of such corporate bang-for-the-buck measures. It tells you what earnings are
generated from invested capital or assets.

• ROA for public companies can vary substantially and are highly dependent on the industry in which
they function so the ROA for a tech company won't necessarily correspond to that of a food and
beverage company. This is why when using ROA as a comparative measure, it is best to compare it
against a company's previous ROA numbers or a similar company's ROA.

The ROA figure gives investors an idea of how effective the company is in converting the money it invests
into net income. The higher the ROA number, the better, because the company is able to earn more money with
a smaller investment. Put simply, a higher ROA means more asset efficiency.

ROA= Net income (EAT) / Average total asset

For example, pretend Sam and Milan both start hot dog stands. Sam spends $1,500 on a bare-bones metal cart,
while Milan spends $15,000 on a zombie apocalypse-themed unit, complete with costume. Let's assume that
those were the only assets each firm deployed. If over some given period, Sam earned $150 and Milan earned
$1,200, Milan would have the more valuable business but Sam would have the more efficient one. Using the
above formula, we see Sam’s simplified ROA is $150 / $1,500 = 10%, while Milan's simplified ROA is
$1,200/$15,000 = 8%.

DuPont Return on Assets: Net profit margin, total asset turnover, and return on assets are usually reviewed together
because of the direct influence that the net profit margin and the total asset turnover have on return on assets. This book
reviews these ratios together; when reviewed together, they are collectively termed the DuPont return on assets .

The rate of return on assets can be broken down into two component ratios: the net profit margin and the total asset
turnover. These ratios allow for improved analysis of changes in the return on assets percentage. E. I. DuPont de Nemours
and Company developed this method of separating the rate of return ratio into its component parts. Compute the DuPont
return on assets as follows:

Return on Asset= Net Profit Margin x Asset turnover

Net Income (EAT) / Total Assets = (Net Income (EAT)/ Net Sales) × (Net Sales / Average Total Assets)
Separating the ratio into the two elements allows for
discussion of the causes for the increase in the
percentage of return on assets.
Variation in Computation of DuPont Ratios
Considering Only Operating Accounts It is often
argued that only operating assets should be
considered in the return on asset calculation.
Operating assets exclude construction in
progress, long-term investments, intangibles, and
the other assets category from total assets.
Similarly, Operating income—the profit
generated by manufacturing, merchandising, or
service functions—that equals net sales less the
cost of sales and operating expenses should also be
used instead of net income. The DuPont analysis,
considering only operating accounts, requires a
computation of operating income and operating
assets.

RATIOS WRT OPERATIONS

Operating Income Margin

The operating margin measures how much profit a

company makes on a dollar of sales after paying
for variable costs  of production, such as wages
and raw materials, but before paying interest or
tax. It is calculated by dividing a company’s
operating income by its net sales. Higher ratios are
generally better, illustrating the company is
efficient in its operations and is good at turning
sales into profits. 

• The operating margin represents how efficiently a company is able to generate profit through its core operations.

• It is expressed on a per-sale basis after

accounting for variable costs but before
paying any interest or taxes (EBIT).

Operating Income Margin = Operating

Income / Net Sales

OPERATING ASSET RATIOS

Operating Asset Turnover

This ratio measures the ability of operating assets to generate sales dollars.

• The operating asset turnover ratio is an efficiency ratio that identifies the revenue generation capabilities
of a company’s operating assets.

• Examples of operating assets include

PP&E, cash, accounts receivable,
inventory, and land.
• The operating asset turnover ratio is
calculated as sales divided by
operating assets.
The operating asset turnover ratio, an
efficiency ratio, is a variation of the total asset
turnover ratio and identifies how well a company is using its operating assets to generate revenue.

Operating assets are assets that are essential to the day-to-day operations of a business. In other words,
operating assets are the assets utilized in the ordinary income-generation process of a business.

Operating Asset Turnover = Net Sales / Average Operating Assets

Return on Operating Assets

The return of operating assets measures a company’s ability to generate profit from the operational assets’ income.
In other words, it shows how profitable your company is by only using your day to day resources. Some operating
assets examples are account receivables, cash, inventories, and fixed assets.

The assets responsible for producing revenue have to perform business functions; however, the return provided by
these assets will tell the manager precisely how valuable they are. Depending on their performance, they may either
be removed or replaced.

Return on Operating Assets = Operating Income / Average Operating Assets

DuPont Return on Operating assets

The return on operating assets can be viewed in terms of

the DuPont analysis that follows:

DuPont Return on Operating Assets =

Operating Income Margin × Operating Asset
Turnover
Sales to Fixed Assets

This ratio measures the firm’s ability to make productive use of its property, plant, and equipment by
generating sales dollars.
• Since construction in progress does not contribute to current sales, it should be excluded from
net fixed assets.
• This ratio may not be meaningful because of old fixed assets or a labor-intensive industry. In
these cases, the ratio is substantially higher because of the low fixed asset base.

Sales to Fixed Assets = Net Sales / Average Net Fixed Assets (Exclude Construction in
Progress)
Sales to fixed asset ratio is an asset utilization measure that allows investors to understand how well a company uses
its assets to generate revenue.  This ratio shows how many times the company’s fixed assets are turned over in a
year.  A high ratio is an indicator of efficient utilization of fixed assets to generate larger amounts of sales revenue.
Meanwhile, a low ratio implies that the company is not efficiently utilizing its fixed assets to revenue generation. Or it
can also be interpreted that the product the company is manufacturing is not in demand, so the investment in the
fixed assets may not yield positive results

Return on Investment (ROI)

The return on investment (ROI) applies to ratios measuring the income earned on the invested capital. These types of
measures are widely used to evaluate enterprise performance.

Since return on investment is a type of return on capital, this ratio measures the ability of the firm to reward those who
provide long-term funds and to attract providers of future funds.

Return on Investment = Net Income Before Noncontrolling Interest and Nonrecurring Items +
((Interest Expense) × (1 x Tax Rate)) / Average (Long term Liabilities + Equity)
This ratio evaluates the earnings performance of the firm without regard to the way the investment is
financed. It measures the earnings on investment and indicates how well the firm utilizes its asset base.
Return on Total Equity

The return on total equity measures the return to both common and preferred stockholders.
Return on Total Equity = Net Income Before Nonrecurring Items - Dividends on Redeemable Preferred
Stock / Average Total Equity
Preferred stock subject to mandatory redemption is termed redeemable preferred stock. The SEC requires that
redeemable preferred stock be categorized separately from other equity securities because the shares must be
redeemed in a manner similar to the repayment of debt. Most companies do not have redeemable preferred stock. For
those firms that do, the redeemable preferred stock is excluded from total equity and considered part of debt.

Similarly, the dividends must be deducted from income. They have not been deducted on the income statement,
despite the similarity to debt and interest, because they are still dividends and payable only if declared.

Return on Common Equity

This ratio measures the return to the common stockholder, the residual owner.

Return on Common Equity = Net Income Before Nonrecurring Items - Preferred Dividends / Average
Common Equity
The net income appears on the income statement. The preferred dividends appear most commonly on the statement of
stockholders’ equity. Common equity includes common capital stock and retained earnings less common treasury
stock. This amount equals total equity minus the preferred capital and any noncontrolling interest included in the
equity section
Gross Profit Margin

Gross profit equals the difference between net sales revenue and the cost of goods sold. The cost of goods sold is the
beginning inventory plus purchases minus the ending inventory. It is the cost of the product sold during the period.
Changes in the cost of goods sold, which represents such a large expense for merchandising and manufacturing firms,
can have a substantial impact on the profit for the period. Comparing gross profit with net sales is termed the gross
profit margin.

Gross Profit Margin = Gross Profit / Net Sales

This ratio should then be compared with industry data or analyzed by trend analysis.

Exhibit 8-16 illustrates trend analysis. In this illustration, the gross profit margin has declined
substantially over the three-year period. This could be attributable to a number of factors:
1. The cost of buying inventory has increased more rapidly than have selling prices.
2. Selling prices have declined due to competition.
3. The mix of goods has changed to include more products with lower margins.
4. Theft is occurring. If sales are not recorded, the cost of goods sold figure in relation to the sales
figure is very high. If inventory is being stolen, the ending inventory will be low and the cost of
goods sold will be high.
Gross profit margin analysis helps a number of users. Managers budget gross profit levels into their
predictions of profitability. Gross profit margins are also used in cost control. Estimations utilizing
gross profit margins can determine inventory levels for interim statements in the merchandising
industries. Gross profit margins can also be used to estimate inventory involved in insured losses. In
addition, gross profit measures are used by auditors and the Internal Revenue Service to judge the
accuracy of accounting systems.
The Relationship Between Profitability Ratios
Technically, a ratio with a profit figure in the numerator and some type of “supplier of funds” figure in
the denominator is a type of return on investment. Another frequently used measure is a variation of the
return on total assets.
Compute this return on total assets variation as follows:
Return on Total Assets Variation = Net Income + Interest Expense / Average Total Assets
This ratio includes the return to all suppliers of funds, both long- and short-term, by both creditors and
investors.
It differs from the return on assets ratio previously discussed because it adds back the interest. It differs
from the return on investment in that it does not adjust interest for the income tax effect, it includes
short-term funds, and it uses the average investment. It will not be discussed or utilized further here
because it does not lend itself to DuPont analysis.
Rates of return have been calculated on a variety of bases. The interrelationship between these ratios is
of importance in understanding the return to the suppliers of funds. Exhibit 8-15 displays a comparison
of profitability measures for Nike. The return on assets measures the return to all providers of funds
since total assets equal total liabilities and equity. This ratio will usually be the lowest since it includes
all of the assets. The return on investment measures the return to long-term suppliers of funds, and it is
usually higher than the return on assets because of the relatively low amount paid for short-term funds.
This is especially true of accounts payable. The rate of return on total equity will usually be higher than
the return on investment because the rate of return on equity measures return only to the shareholders.
A profitable use of long-term sources of funds from creditors provides a higher return to shareholders
than the return on investment. In other words, the profits made on long-term funds from creditors were
greater than the interest paid for use of the funds.
Common stockholders absorb the greatest degree of risk and, therefore, usually earn the highest return.
For the return on common equity to be the highest, the return on funds obtained from preferred
stockholders must be more than the funds paid to the preferred stockholders. For Nike the return on
total equity and the return on common equity are the same because they do not have preferred equity.