Wednesday, April 28, 2010

Profitability ratios

These measures evaluate a company's level of profitability by expressing sales and profits as a percentage of various other items.

  • Return on assets (ROA). ROA provides a quantitative description of how well a company has invested in its assets.
    To calculate ROA, divide net income by assets.
  • Return on equity (ROE). ROE shows the return on the portion of the company's financing that is provided by owners.
    To calculate ROE, divide net income by owner's equity.
  • Return on Sales (ROS). Also known as profit margin, ROS is a way to measure how sales translate into profit. For example, if a company earns $10 for every $100 in sales, the ROS is 10/100 or 10%.
    To calculate ROS, divide net income by the total sales volume.
  • Gross margin. A ratio that measures the percentage of gross profit relative to sales revenue. Gross profit is profit or income after deducting the cost of goods sold. A decline in gross margin may signal that a company won't be able to meet its expense obligations. To calculate gross margin, first calculate gross profit by subtracting cost of goods sold from sales. Then calculate gross margin by dividing gross profit by sales.
  • Earnings Before Interest and Taxes (EBIT) margin. Many analysts use this indicator, also known as operating margin, to see how profitable a company's operating activities are.
    To calculate the EBIT margin, divide net sales by EBIT.

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