Výsledek: 70%, Test/quiz: Profitability indicators, Nebojsa Drazevic

Gross margin is one of profitability indicators.

It can be expressed as

• a difference

• %

Comparisons

• gross margin % will vary considerably between industries, so comparing companies in different industries makes little sense
• it makes sense to compare with the industry average or with previous years

Margin is often confused with mark-up, which has cost of goods sold instead of sales in the denominator. Mark-up is therefore a little higher than margin.

Net margin (Return On Revenue - ROR" or Return On Sales - ROS ") is one of profitability indicators. It shows how much profit is generated from the unit revenue. It is a useful indicator to control costs as the formula for operating ratio can be easily derived from it.

Calculation formula

Profit may be EBIT (PBIT), EBT (PBT) or EAT (PAT).

Comparison

• suitable mainly for comparisons within the company - especially as an indicator of costs increases over time as the decreasing ratio can indicate rising costs, and vice versa
• comparisons between companies makes sense only, if these are very similar businesses in the same industry where similar cost levels and gross margin % can be expected
• appropriate is the comparison with the industry average

Value added (VA) is one of profitability differential indicators and it shows the value that the entity has added to external inputs. Value added is obtained as a difference between revenues from sales of goods/services and costs for inputs (usually direct costs).

There are two alternatives for value added:

• Economic Value Added (EVA)
• Market value added (MVA)

NOPAT = Net Operating Profit After Tax

Return on equity (ROE) is one of profitability indicators, which shows how effectively the entity manages resources invested by the shareholders/partners.

Calculation formula

 * can be in the form of average of the beginning and end of the period

Comparison and recommended value

If the entity is financed only by equity, the ROE can be consistent with ROCE.

Comparison with other companies makes sense only within the same industry. It is appropriate to look to the trend development over a longer period of time.

The main disadvantage of ROE

is that it does not take into account loans (or rather liabilities), so the reason for good ROE can also be higher indebtedness (especially in the case of cheaper loans). Because of this, ROE is mainly used by shareholders (it makes more sense to use ROCE internally) and debt ratios shall be analyzed parallel as well.

Return on assets (ROA) is one of profitability indicators reveals how much profit will be generated by unit of assets. It expresses how effectively the company manages its assets.

Calculation formula

* often average from the beginning and ending balance

The numerator is usually EAT (PAT) or EBIT.

About ROA

The higher is the net margin and the higher asset turnover, the higher is ROA.

ROA is usually lower in companies with naturally high asset (e.g. utilities). Conversely, companies with low assets (e.g. services) tend to have higher ROA.

Comparisons:

• with companies in the same industry, even if they have different proportion of equity and debt (advantage against ROE). Comparison with companies in different industries does not make much sense because each industry has different net margins, asset turnover and capital intensity.
• appropriate comparison is with the past in the entity

Operating ratio is one of profitability indicators. Its formula can be easily derived from the profit margin formula (Return on sales). It expresses how much cost is incurred for each unit of sales.

Calculation formula

Comparison

• it is particularly suitable for comparison within the company - especially as an indicator of operating costs (OPEX) increases over time, because increase of the ration can indicate rising costs, and vice versa
• comparisons between companies makes sense only if they are very similar businesses in the same industry where we can expect similar cost level and gross margin %
• appropriate comparison is with the industry average

Return on costs (ROC) is one of profitability indicators. It expresses the amount of profit attributable to unit total cost.

Calculation formula

Comparison

• it is particularly suitable for comparison within the company - especially as an indicator of changes in costs over time as reduction of the ratio can indicate rising costs, and vice versa
• comparisons between companies makes sense only if they are very similar businesses in the same industry where we can expect similar cost level and gross margin %
• appropriate comparison is with the industry average

ROCE indicates how much profit will be generated by the unit of the long-term investment.