Ratio Analysis - profitability ratios – 1

MANAGEMENT ACCOUNTING
RATIO ANALYSIS
BY:
SMT.UMA MINAJIGI REUR
HEAD, DEPT. OF COMMERCE & MANAGEMENT
SMT. V G DEGREE COLLEGE FOR WOMEN, KALABURAGI

MANAGEMENT ACCOUNTING
RATIO ANALYSIS
PROFITABILITY RATIOS – 1

Classification of Accounting Ratio
Types of ratios are given below:
1. Liquidity Ratios
2. Leverage Ratio
3. Turnover Ratio
4. Profitability Ratio

Turnover Ratios or Activity Ratios or Performance Ratios
Turnover ratios are used to determine how efficiently the financial assets and
liabilities of an organization have been used for the purpose of generating revenues.
These ratios measure the operating efficiency of an enterprise.
The types of Turnover ratios are: –
1. Inventory Turnover Ratio or Stock Turnover Ratio.
2. Debtors Turnover Ratio.
3. Creditors Turnover Ratio.
4. Cash Turnover Ratio.
5. Working Capital Turnover Ratio.
6. Fixed Assets Turnover Ratio.
7. Capital Turnover Ratio or Sales to Net Worth Ratio.

PROFITABILITY RATIOS
• Profit is a measure of efficiency & control of business activities.
• Measurement of Profit is a function of Accounts, whereas measurement of Profitability is a function of
Financial Analysis.
• Profitability ratio reflect the capacity to earn profits. Such capacity to earn profit depends upon two
factors ---- Sales and Investment.
Sales:
Relationship between profit and sales is shown by computing “Profit margin ratios”.
Investment:
Relationship between profit and investment is shown by computing “Rate of Return ratios”.

Sales:
Relationship between profit and sales is shown by computing “Profit margin ratios”.
Investment:

Sales:
Relationship between profit and sales is shown by computing “Profit margin
ratios”.
1. Gross Profit Ratio
2. Operating Ratio
3. Expenses Ratio
4. Operating Profit Ratio
5. Net Profit Ratio

Investment:
1. Return on Investment (ROI)
2. Return on Total Resources
3. Return on Equity (ROE)
4. Earning Per Share Ratio (EPS)
5. Fixed Assets Turnover Ratio
6. Debt to Total Fund Ratio

GROSS PROFIT RATIO
It is calculated by dividing gross profit by the Net Sales.
Gross Profit: The difference between net sales and cost of goods sold is known as gross
profit.
Gross Profit = Net Sales – Cost of goods sold.
Net Sales = Total Sales – Sales Return
Cost of goods sold = Opening Stock + Purchases + All direct expenses – Closing Stock
G𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬
* 100

GROSS PROFIT RATIO
Interpretation:
Compare the gross profit of last year and those of other concern carrying similar business.
It actual gross profit is high, it indicates good results.
It actual gross profit is low, it indicates poor results.

Illustration 1:
From the following information calculate gross profit ratio.
Cash sales 25% of total sales, Purchases Rs. 11,80,000, Closing stock Rs.3,60,000,
Credit sales Rs.8,22,000, Opening Stock Rs.1,80,000
1. Calculation of Total Sales:
If total sales 100
Less: Cash sales 25
Credit Sales 75
If credit sales 75 ; total sales 100
If credit sales 8,22,000
Total Sales =
𝟖,𝟐𝟐,𝟎𝟎𝟎
𝟕𝟓
* 100 = 10,96,000
Solution 1:

Cost of Goods Sold
Opening Stock 1,80,000
Add: Purchases 11,80,000
13,60,000
Less: Closing Stock 3,60,000
Cost of Goods sold 10,00,000
Cash sales 25% of total sales, Purchases Rs. 11,80,000, Closing stock Rs.3,60,000, Credit sales Rs.8,22,000,
Opening Stock Rs.1,80,000
2. Calculation of Total Sales:
Gross Profit = Net Sales – Cost of goods sold.
Gross Profit = 10,96,000– 10,00,000
= 96,000

Cash sales 25% of total sales, Purchases Rs. 11,80,000, Closing stock Rs.3,60,000, Credit sales Rs.8,22,000,
Opening Stock Rs.1,80,000
3. Calculation of Gross Profit:
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
* 100
𝟗𝟔,𝟎𝟎𝟎
𝟏𝟎,𝟗𝟔,𝟎𝟎𝟎
* 100 = 8.759 = 8.76 %

OPERATING RATIO
It is calculated by dividing Cost of goods sold and operating expenses by the Net Sales.
This ratio establishes the relationship between total operating expenses and sales. Total
operating expenses include cost of goods sold, administrative expenses, financial expenses
and selling expenses.
Formula:
Cost of goods sold = Opening Stock + Purchases + All direct expenses – Closing Stock
Operating expenses = Administrative expenses + Financial expenses + Selling expenses
O𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝+𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬
* 100

Illustration 2:
From the following income statement calculate Operating ratio for all the 3 years.
Particulars 2015 2016 2017
Net Sales 60,000 1,00,000 1,20,000
Less: Cost of Sales 40,000 70,000 80,000
Gross Profit 20,000 30,000 40,000
Less: Expenses
Selling Expenses 6,000 7,000 9,000
General & Administrative Expenses 4,000 4,000 4,000
Operating Expenses 10,000 11,000 13,000
Operating Income 10,000 19,000 26,000

Solution 2:
* 100
Particulars 2015 2016 2017
Net Sales 60,000 1,00,000 1,20,000
Cost of Sales 40,000 70,000 80,000
Operating Expenses 10,000 11,000 13,000
* 100
𝟒𝟎,𝟎𝟎𝟎+𝟏𝟎,𝟎𝟎𝟎
𝟔𝟎,𝟎𝟎𝟎
* 100 =
𝟓𝟎,𝟎𝟎𝟎
𝟔𝟎,𝟎𝟎𝟎
* 100 = 83.33%
2015:
𝟕𝟎,𝟎𝟎𝟎+𝟏𝟏,𝟎𝟎𝟎
𝟏,𝟎𝟎,𝟎𝟎𝟎
* 100 =
𝟖𝟏,𝟎𝟎𝟎
𝟏,𝟎𝟎,𝟎𝟎𝟎
* 100 = 81%
𝟖𝟎,𝟎𝟎𝟎+𝟏𝟑,𝟎𝟎𝟎
𝟏,𝟐𝟎,𝟎𝟎𝟎
* 100 =
𝟗𝟑,𝟎𝟎𝟎
𝟏,𝟐𝟎,𝟎𝟎𝟎
* 100 = 77.5%
2016:
2017:
Given data:

EXPENSES RATIO
These ratios are calculated by dividing each expenses each expenses by the net sales.
These expenses are also known as supporting ratios or operating inefficiency of the
business. The following are a few expenses ratios:
F𝐚𝐜𝐭𝐨𝐫𝐲 𝐄𝐱𝐩. 𝐑𝐚𝐭𝐢𝐨 =
𝐅𝐚𝐜𝐭𝐨𝐫𝐲 𝐄𝐱𝐩𝐞𝐧𝐬𝐞𝐬
* 100
a) Factory Expenses Ratio:
A𝐝𝐦𝐢𝐧𝐢𝐬𝐭𝐫𝐚𝐭𝐢𝐨𝐧 𝐄𝐱𝐩. 𝐑𝐚𝐭𝐢𝐨 =
𝐀𝐝𝐦𝐢𝐧𝐢𝐬𝐭𝐫𝐚𝐭𝐢𝐯𝐞 𝐄𝐱𝐩𝐞𝐧𝐬𝐞𝐬
* 100
b) Administrative Expenses Ratio:
S𝐞𝐥𝐥𝐢𝐧𝐠 𝐄𝐱𝐩. 𝐑𝐚𝐭𝐢𝐨 =
𝐒𝐞𝐥𝐥𝐢𝐧𝐠 𝐄𝐱𝐩𝐞𝐧𝐬𝐞𝐬
* 100
c) Selling Expenses Ratio:
N𝐨𝐧 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐄𝐱𝐩. 𝐑𝐚𝐭𝐢𝐨 =
N𝐨𝐧 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐄𝐱𝐩𝐞𝐧𝐬𝐞𝐬
* 100
d) Non operating Expenses Ratio:

OPERATING PROFIT RATIO
It is calculated by dividing Operating profit by the Net Sales.
Formula:
Operating profit is also known as EBIT ( Earnings before Interest & Taxes)
Operating Profit = Net Profit + Non-Operating Expenses – Non-Operating Incomes
Or
Operating Profit = Gross Profit – Operating Expenses
Or
Sales – Variable Cost – Fixed Cost
O𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭
* 100

OPERATING PROFIT RATIO
Interpretation:
Standard Ratio is 10%
If operating profit ratio is 10% or more , it indicates operating efficiency of the business.
If operating profit ratio is less than 10% , it indicates operating inefficiency of the business.

NET PROFIT RATIO
It is calculated by dividing Net profit by the Net Sales.
Net profit after tax: with the help of this ratio, the efficiency of the management in
manufacturing, selling, administration and other activities of the firm can be assessed.
This ratio is the overall measure of the firm’s profitability.
Formula:
Interpretation:
High ratio indicates that profitability of concern is good.
Low ratio indicates that profitability of the concern is poor.
N𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨(𝐀𝐟𝐭𝐞𝐫 𝐓𝐚𝐱) =
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐚𝐟𝐭𝐞𝐫 𝐓𝐚𝐱
* 100

Illustration 3:
From the following information calculate Net profit ratio.
Sales Rs.15,00,000, cost of goods sold Rs.9,00,000, Office & Administrative
expenses Rs.3,00,000, Provision for tax Rs.1,20,000.
1. Calculation of Net Profit:
Solution 3:
PArticulars Amount
Sales 15,00,000
Less: Cost of Goods Sold 9,00,000
Gross profit 6,00,000
Less: Office & Adm Expenses 3,00,000
Net Profit before tax 3,00,000
Less: Tax 1,20,000
Net Profit after tax 1,80,000

2. Calculation of Net Profit Ratio:
N𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨(𝐁𝐞𝐟𝐨𝐫𝐞 𝐓𝐚𝐱) =
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐛𝐞𝐟𝐨𝐫𝐞 𝐓𝐚𝐱
* 100
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐚𝐟𝐭𝐞𝐫 𝐓𝐚𝐱
* 100
N𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨(𝐁𝐞𝐟𝐨𝐫𝐞 𝐓𝐚𝐱) =
𝟑,𝟎𝟎,𝟎𝟎𝟎
𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎
* 100 = 20%
𝟏,𝟖𝟎,𝟎𝟎𝟎
𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎
* 100 = 12%

Ratio Analysis - profitability ratios – 1

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Similar a Ratio Analysis - profitability ratios – 1

Similar a Ratio Analysis - profitability ratios – 1 (20)

Más de uma reur

Más de uma reur (20)

Último

Último (20)

Ratio Analysis - profitability ratios – 1