Balance Sheets ; Cash Flow Statements ; Income Statements ; Return on Assets Financial ratios are relationships determined from a company's financial information and used for comparison purposes.

This guide introduces you to several methods for analyzing your company's operations and calculating the profitability of your businessm WHAT TO EXPECT Many entrepreneurs start their business at least in part because of pride of ownership and the satisfaction that comes from being their own boss.

In addition, of course, you almost certainly also started your business to generate profits. This training guide will introduce you to several methods that will help you analyze your company's operations and compute the profitability of your business.

Among the tools to which you will be introduced are profitability ratios, break-even analysis, return on assets and return on investment. Some of these concepts, and some of the vocabulary we will use to describe them, may be new to importance profitability ratios business plan. But we've tried to explain the terminology and concepts as they are introduced.

Where appropriate, we've pointed you to additional sources of information. In the following pages we will introduce you to three methods of analyzing how well your company is doing: Margin or profitability ratios Break-even analysis based on revenues and on units sold Return on assets and on investment Watch Out For…Before you get started, you or your bookkeeper should have prepared an income or profit and loss statement for your business.

The techniques to which we will be introducing you on the following pages are intended to make your income statement more understandable and meaningful for you.

If an income statement has not been prepared, the information below on constructing a common size income statement will not be of much relevance, and the data you need for break-even analysis may be missing.

This guide looks at several aspects of financial ratio analysis. In case your high school math is a bit rusty, a ratio is simply a comparison between two numbers.

If a basketball team has won six games and lost three, its ratio of wins to losses is six to three, which is equivalent to a ratio of two to one. In the business arena, the most commonly used kind of financial ratios are various comparisons of two numbers from a company's financial statements, such as the ratio of net income to annual sales.

A ratio can be written in several different ways: Gross Profit Margin Ratio. Net Profit Margin Ratio. Other Common Size Ratios Don't worry if some or even all of these terms are unfamiliar.

We will define each of them as we go along, and will explain how you can best use them. The three measurements of profits — gross profit, operating profit and net profit — all come from your company's income statement.

As a reminder, here is a definition of gross profit, operating profit and net profit. As you will see, the definitions build on one another, reflecting the way net sales are affected by increasing expense components. Net profit is what is known as "the bottom line.

Gross profit is the difference between sales and the costs of goods sold. Operating profit is the difference between sales and the costs of goods sold PLUS selling and administrative expenses. And finally, net profit is the difference between net sales and ALL expenses, including income taxes.

The three ways of expressing profit can each be used to construct what are known as profitability ratios. This is done by dividing each item into net sales and expressing the result as a percentage. There are several reasons that ratios are expressed as percentages.

This makes it easy to compare your company's results at different time periods. It also allows you to compare your company's results with those of your peers or competitors, and with industry "benchmark" ratios which will be discussed in more detail below.

It's easier to discuss these ratios using actual numbers, so we've included the following income statement for the fictional Doobie Company.

Look at line numbers 3, 9, and We will use the Doobie Company's gross profit line 3operating Income line 9 and net income line 14 numbers to compute the three profitability ratios.

Cost of goods sold, Net profit34, Gross Profit Margin Ratio Gross profit is what is left after the costs of goods sold have been subtracted from net sales. Cost of goods sold, also called "cost of sales," is the price paid by your company for the products it sold during the period you are looking at.

It is the price of the goods, including inventory or raw materials and labor used in production, but it does not include selling or administrative expenses. The ratio of gross profit as a percentage of sales is an important indicator of your company's financial health.

Without an adequate gross margin, a company will be unable to pay its operating and other expenses and build for the future. Here is the formula to compute the gross profit margin ratio: Let's use the income statement data for the fictitious Doobie Company and compute the gross margin ratio for the company:Profitability ratios are crucial ratios in financial analysis for company investors.

Analyzing the profitability ratios is an important task. The Balance Small Business. First, they represent assets that a company needs to operate on.

Liquidity ratios are used to measure a company’s ability to meet current obligations as they come due. There are three that matter the most to a business owner and lender: The current ratio indicates the extent to which current assets are available to satisfy current liabilities.

In fact, there are ratios that, properly understood and applied, can help make you a more informed investor. (Find out how this method can be applied strategically to increase profit. Check out. Ratio analysis is a useful management tool that will improve your understanding of financial results and trends over time, and provide key indicators of organizational performance.

Managers will use ratio analysis to pinpoint strengths and weaknesses from which strategies and initiatives can be formed. Net Profit Margin: When doing a simple profitability ratio analysis, the net profit margin is the most often margin ratio used.

The net profit margin shows how much of each sales dollar shows up as net income after all expenses are paid. Owners and managers should carefully watch the three most important profitability ratios: gross profit, operating profit, and net profit.

The usefulness to you of the other ratios calculated from the income statement will vary depending on the specific line item and the type of business you are in.

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Profitability Ratios - Calculate Margin, Profits, Return on Equity (ROE)