Question

a) Please describe in detail what PROFITABILITY RATIO attempt to measure?

b) Where would you obtain such information?

c) For what period of time and what other comparisons would assist your analysis.

d) What management policies would have a positive affect on this analysis tool.

Answer 1

a). Profitability ratios determine the ability of a business to generate earnings in comparison to its expenses. It shows how much a business is generating profits on the invested amount after incurring costs. For example there are various profitability ratios like Gross Profit Ratio, Net Profit Ratio, Return on Assets ratio, Return on Equity ratio etc.
Different profit ratios are used to measure a company's profitability at various cost levels, including gross margin, operating margin, pretax margin and net profit margin. The margins shrink as layers of additional costs are taken into consideration, such as cost of goods sold (COGS), operating and nonoperating expenses, and taxes paid. Gross margin measures how much a company can mark up sales above COGS. Operating margin is the percentage of sales left after covering additional operating expense. The pretax margin shows a company's profitability after further accounting for nonoperating expense. Net profit margin concerns a company's ability to generate earnings after taxes.

b). Such Inflormation can be obtained from financial statements of the companies. In those statements choose the figures required to calculate the profitability ratios and apply the formula for a particular ratio.

c). For analysis Profitability ratios must be there for current year and previous years. By comparing the ratios of a company from past years, it can be identified whether a business is performing good or not and it there any improvement arisen from past years or is there any improvement in profitability of the business or not.
Profitability ratios of competitors are also can be used to compare the business with its competitors in the market in order to check , where the business currently stands, which company is doing good or generating better profits than others.

d). Management policies for reducing the costs or expenses of their goods or services and improving their sales and selling prices will result in improvement of these ratios. Policies should analyse how to gain control on cost changes and how to improve the business market share which will simuntaneously improves its profitability.