Chapter 7

Profitability
Ratio

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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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Objectives

Define Profitability
Solve profitability ratio

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Review
Formula to compute:
Gross Profit
Operating Profit Margin
Net Profit or Net Income

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Financial Statement Analysis

• There are different users of
Financial statement
• Financial statement analysis can
be used by managers, equity
investors, creditors, regulators,
labor unions, employees , the
public and potential investors and
creditors
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Financial Statement Analysis

• Is used for investment and credit
decisions.
• It also used for regulating
companies such as what the
Energy Regulatory Commission
does for power distribution
companies and other energy
ocmpanies.
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Profitability
Profitability
- refers to the company’s
ability to generate earning.
-Most important goals of
business

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Profitability

• Capacity to make a profit

• Profit is what is left over
from income earned after
you have deducted all costs
and expenses related to
earning the income

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Types of Profitability Ratios

Common Types of Profitability Ratios
– Gross Profit Margin
– Operating Profit Margin
– Net Profit Margin
– Return on Assets,(Return on Investment-ROI)
– Return on Equity
– Return on Capital Employed

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Seatwork
1. All the incoming income from your
household
Father’s Income
Mother’s Income
Brother / Sister / Siblings / Guardian
Other Income – Business
Pension
2. List all the household expenses:
education, transportation, utilities, misc
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Profitability Ratio
Return on Equity (ROE)
= Net Income
Stockholders’ Equity
Return on Asset (ROA)
= Operating Income
Total Assets

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Gross Profit
Gross Profit shows how many pesos of
gross profit is earned for every pesos of
sale.
It shows the ability of a company to cover
its manufacturing cost from its sales.
Gross Profit = Sales – Cost of Goods Sold
Net Sales = Total Sales – Sales Return

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Gross Profit
Gross Profit Margin = Gross Profit
Sales
The Ratio comes in percentage
form and higher the ratio the better
is for the company.

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Operating Profit Margin

Shows how many pesos of operating profit
is earned for every pesos of sale.
It measures the amount of income
generated from the core business of a
company
Operating Profit = Non-Operating Expenses
– (Non-
Sales
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Operating Profit Margin

Shows how many pesos of operating profit
is earned for every pesos of sale.
It measures the amount of income
generated from the core business of a
company
Operating Profit Margin = Operating Income
Sales

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Net Profit Margin

Measures how much net profit a company
generates for every peso of sale or
revenues that it generates
Net Profit Margin = NetIncome
Sales

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Sample of Statement of Financial 1-16
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Position as of Dec 31,2014

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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

ROE = (Net Income / Stockholder Equity ) x 100%

= (2,659,087 / 12,478,559 ) x 100%
= 21.31% (2014)
means for every 1.00 pesos sale of company generates
21.31% in gross profit. 18
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265
Operating Profit Margin (2014) = (Operating Income /Sales ) x 100%
=( 4,048,696 / 52,501,085 ) x 100%
= 7.71%
The 7.71% Operating Profit margin means that out of P1.00
sales or revenue that JSC Foods generate, the company
earned 7.71 Pesos after deducting cost of sales and 19
operating expenses Before the effect of income taxes
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Operating Profit Margin (2013) = (Operating Income /Sales ) x 100%

=( 3,159,791 / 47,345,223 ) x 100%
= 6.67
The 6.67% Operating Profit margin means that out of P1.00
sales or revenue that JSC Foods generate, the company
earned 6.67 Pesos after deducting cost of sales and 20
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Operating Profit Margin (2012) = (Operating Income /Sales ) x 100%

=( 2,800,488 / 42,174,283 ) x 100%
= 6.64
The 6.64% Operating Profit margin means that out of P1.00
sales or revenue that JSC Foods generate, the company
earned 6.64 Pesos after deducting cost of sales and 21
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Operating Profit Margin (2011) = (Operating Income /Sales ) x 100%

=( 1,067,166/ 38,340,257 ) x 100%
= 5.15%
The 5.15%% Operating Profit margin means that out of
P1.00 sales or revenue that JSC Foods generate, the
company earned 5.15 Pesos after deducting cost of sales 22
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Operating Profit Margin (2010) = (Operating Income /Sales ) x 100%

=( 841,265/ 35,336,643 ) x 100%
= 4.25%
The 4.25%% Operating Profit margin means that out of
P1.00 sales or revenue that JSC Foods generate, the
company earned 4.25 Pesos after deducting cost of sales 23
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Net Profit Margin (2014) = (Net Income /Sales ) x 100%

=( 2,659,087 / 52,501,085 ) x 100%
= 5.06%
In 2014, JSC Foods Corp. earned P5.06 for every P1.00 of
revenues generated. 24
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Net Profit Margin (2013) = (Net Income /Sales ) x 100%

=( 2,036,854 / 47,345,223 ) x 100%
= 0.04%
In 2013, JSC Foods Corp. earned P0.04 for every P1.00 of
revenues generated. 25
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Exhibit 2.1: JSC Food Corporation
Statement of Profit or Loss
For the Years Ending Dec. 31, 2010-2014

  2014 2013 2012 2011 2010

Net Sales 52,501,085 47,345,223 42,174,283 38,340,257 35,336,643
Cost of Sales 41,954,730 37,988,628 33,980,174 31,439,011 29,329,413
Gross Profit 10,546,355 9,356,595 8,194,109 6,901,246 6,007,229
Operating
Expenses 6,497,659 6,196,804 5,393,621 4,926,723 4,505,422
Operating Income 4,048,696 3,159,791 2,800,488 1,974,523 1,501,807
Interest Payable 250,000 250,000 250,000 450,000 300,000
Income before
taxes 3,798,696 2,909,791 2,550,488 1,524,523 1,201,807
Taxes 1,139,609 872,937 765,146 457,357 360,542
Net Income 2,659,087 2,036,854 1,785,342 1,067,166 841,265

Net Profit Margin (2012) = (Net Income /Sales ) x 100%

=( 1,785,342 / 42,174,283 ) x 100%
= 0.04%
In 2012, JSC Foods Corp. earned P0.04 for every P1.00 of
revenues generated. 26
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 Quick ratio 1-28
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• Quick ratio – company’s ability to pay all

current liabilities if they came due
immediately.
•  Quick Ratio Formula = (Current Assets –
Inventory ) / Current Liabilities

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 Current ratio 1-29
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• Current ratio – measures ability to pay

current liabilities with current assets
•  Current Ratio = Current Assets / Current
Liabilities

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 Working Capital 1-30
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• Working capital – measures of current assets

that would remain after all current liabilities were
paid
• Working Capital = Current Assets – Current
Liabilities

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Debt Ratio (round to one decimal Places) 1-31
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Debt Ratio = Total Liabilities / Total Assets

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