Profitability ratios

Profitability ratios

-GROSS PROFIT MARGIN -NET PROFIT MARGIN -RETURN ON CAPITAL EMPLOYED

Interpretation of GPM

-the higher the gross profit margin a business makes the better -the level of gross profit margin made will vary considerably between different markets. -any result gained must be looked at in the context of the industry in which the firm operstes

Definition

A measure of profitability which is a way to measure a company's performance. Profitability is simply the capacity to make a profit, and a profit is what is left over from income earned after you have deduced all costs and expenses related to earning the income.

Net profit margin

As opposed to gross profit margin this ratio measures the relationship between the net profit (profit made after all other expenses have been deducted) and the level of turnover or sales made.

GPM interpretation example

GPM for a business was 25% For every £1 of sales revenue 25p is gross profit

Gross profit margin formula

Gross profit. X100. ------------ Sales turnover. Expressed as a percentage

Comparing NPM with GPM

If the gross profit margin has improved but the net profit margin has declined, this shows that profits made on trading are becoming better, however the expenses incurred in the running of the business are also increasing but at a faster rate than profits, this efficiency is declining.

Purpose

Measure the relationship between gross/ net profit and sales, assets and capital employed

Net profit margin formula

Net profit. X100 ---------- Sales turnover Expressed as a percentage

Comparisons

Previous years net profit margin Other companies in the same industry Should be compared with the gross profit margin

Comparisons

Similar firms in the industry Last years gross profit margin

Gross profit margin

This ratio examines the relationship between the profits made on trading activities only against the level of turnover / sales made.