Profitability Ratios
Profitability Ratio for shareholders: Return On Equity, Return On Capital Employed, Return On Assets, Operating profit, Gross Profit, and Net profit. Interpretations and analysis of profitability ratios. Dupont Analysis of Return On Equity and Return On Capital Employed. so, to calculate the return on equity using the Dupont model, simply multiply the three components that are net profit margin, asset turnover, and equity multiplier.
1) Return On Equity(ROE)
This ratio calculates return on equity shareholder's fund only. It excludes preference shareholder's funds. A high return on equity shows better productivity or efficiency in the utilization of the owner's funds. Return on equity is also called return on net worth. let us understand it by one example. suppose Coca-Cola which is A multinational company has RS 10,00,000 as an earning for equity shareholders, the equity share capital of RS 12,00,000, and reserve and surplus of 20,00,00. The ROE of coca-cola is 31.25%. Investors have to compare the ROE of coca-cola with its industry average and take decisions accordingly. you can go deeper than this by doing a Dupont analysis of ROE for further know-how about return on equity.
2) Return On Capital Employed(ROCE)
It is the degree of return on funds invested in the business. In short, it indicates what return management has made on the resources made available to them before making any distribution of those returns. A higher ratio indicates better efficiency in using long-term funds. It is also called Return On Investment (ROI). suppose coca-cola has earnings before interest and tax of RS 50,00,000 and it has total capital employed of RS 70,00,000. Then return on capital employed is 71.42%. Return on capital employed seems quite good due to better utilization of capital to generate sales and increase in operating profit margin. The objective of return on capital employed is to provide the rate of return on each rupee capital invested in a particular type of business. you can dive deeper into ROCE by doing a Dupont analysis of ROCE.
3) Return On Assets (ROA)
This ratio measures the profitability of the firm in terms of assets employed in the firm. A higher ratio indicates better assets management. suppose coca-cola company has earnings before interest and tax of RS 50,00,000 and total assets of RS 1,00,00,000. then Return on Asset of coca-cola is 50% which denotes assets of the company that has been effectively used for increasing sales and profit of the company.
4) Gross Profit Ratio
A high ratio of gross profits to sales means that the cost of production of the firm is relatively low. suppose coca-cola has annual sales of RS 10,00,00,000 and Group s profit of Rs 4,00,00,000. Then gross profit ratio will be 40%.
5) Operating profit Ratio
Operating profit is also termed as earnings before interest and tax (EBIT). suppose coca-cola has earnings before interest and tax of RS 50,00,000 and annual sales of RS 10,00,00,000. Then the operating profit ratio of Coca-Cola will be 5%.
6) Net Profit Ratio
It measures the overall profitability of the business. Higher is considered as better. suppose coca-cola has a net profit of RS 2,50,00,000 and annual sales of RS 10,00,00,000. Then the net profit ratio of coca-cola will be 25%.
conclusion
All the above ratios are related to the profitability of the business. ROE is one of the major indicators that every shareholder's show knows. Investors shall always study the above ratios of the entity before making any investment. Investors shall make the investment in those companies in which investors know inside out of the business. warren buffets invest in those companies that he uses that company product in day-to-day life like coca-cola. similarly, you can use the technique of warren buffet while investing in any company.
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