Profitability Ratio: Gross Profit Ratio, Net Profit Ratio, Return on Assets, Return on Shareholder Equity
Arjun EP
Profitability Ratio
A company raises funds from different sources.
These funds are equity shares, preference shares, debentures and loan etc.
The long-term investors are equity shareholder and preference shareholder.
Loan providers are debenture holders, banks and financial institutes.
All of above are investors interested in the profit of the company.
The profit must earn by the company otherwise, investors do not like to invest.
Profitability ratios are related to among the sales, return, assets and equity.
It has following groups:
Profitability ratio (related to sales):
· Gross profit margin or ratio
· Net profit margin or ratio
· Operating cost ratio
Profitability ratio (related to investment or assets):
· Return on fixed assets
· Return on total assets
· Return on capital employed
Profitability ratio (related to investors or equity):
· Return on shareholder equity
· Return on common shareholder equity
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Accounting for Share |
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Share in Nepali |
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Debentures |
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Final Accounts: Class 12 |
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Final Accounts in Nepali |
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Work Sheet |
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Ratio Analysis (Accounting Ratio) |
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Fund Flow Statement |
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Cash Flow Statement |
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Theory Accounting Xii |
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Theory: Cost Accounting |
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Cost Accounting |
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LIFO−FIFO |
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Cost Sheet, Unit Costing |
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Cost Reconciliation Statement |
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Gross Profit Ratio (Gross Profit Margin)
It is also called gross profit ratio.
The gross profit should be adequate to cover operating expenses, to provide fixed charge, to pay dividend and make proper reserve.
As more as this ratio, business is also better.
Formulas of profit ratio
|
Gross profit |
= |
Net sales – Cost of goods sold |
|
Net sales |
= |
Sales – Sales return |
|
Cost of goods sold |
= |
Sales – Gross profit |
|
Or |
= |
Opening stock + Net purchased + Carriage inward – Closing stock |
Gross profit ratio = (Gross profit ÷ Net sales) x 100
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4A
Following extracted information is given (amount in $/₹/Rs):
|
Sales |
8,00,000 |
|
Sales return |
80,000 |
|
Opening stock |
1,60,000 |
|
Purchased |
4,80,000 |
|
Purchased return |
1,20,000 |
|
Closing stock |
40,000 |
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Carriage on purchased |
20,000 |
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Required: Gross profit and gross profit ratio or margin
[Answer: Gross profit = Rs 2,20,000; GPR = 30.56%]
SOLUTION:
Given and working note:
Trading Account
|
Particulars |
|
Amount |
Particulars |
|
Amount |
|
To Opening stock |
|
1,60,000 |
By Sales |
800,000 |
|
|
To Purchased |
480,000 |
|
Less: Returned |
(80,000) |
7,20,000 |
|
Less: Returned |
(120,000) |
3,60,000 |
By Closing stock |
|
40,000 |
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To Carriage |
|
20,000 |
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To Gross profit |
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2,20,000 |
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7,60,000 |
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7,60,000 |
Gross profit ratio (GPR)
= (Gross profit ÷ Net sales) x 100
= (220,000 ÷ 720,000) x 100
= 0.3056 x 100
= 30.56%
Net Profit Ratio (Net Profit Margin)
It measures overall profit during an accounting period after deducting all operating expenses.
These operating expenses are administrative expenses, selling expenses and distribution expenses etc.
As more as this ratio, business is also better.
Formula of net profit margin and net profit ratio
Net profit margin (NPM) = (Net profit ÷ Net sales) x 100
Where:
Net sales = Sales – sales return
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4B
Following information is given to you: ($/₹/Rs):
|
Sales |
9,00,000 |
|
Sales return |
80,000 |
|
Opening stock |
1,60,000 |
|
Purchased |
4,80,000 |
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Closing stock |
40,000 |
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Wages |
20,000 |
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Carriage on purchased |
20,000 |
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Administrative expenses |
40,000 |
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Interest on loan |
10,000 |
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Selling expenses |
20,000 |
Required: (a) Gross profit and net profit; (b) Gross profit margin/ratio; (c) Net profit margin/ratio
[Answer: Gross profit = Rs 1,80,000; Net profit = Rs 1,10,000;
GPR = 21.95%; NPR = 13.41%]
SOLUTION:
Trading, Profit and Loss account
|
Particulars |
Amount |
Particulars |
|
Amount |
|
To Opening stock |
1,60,000 |
By Sales |
900,000 |
|
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To Purchased |
4,80,000 |
Less: Returned |
(80,000) |
820,000 |
|
To Carriage |
20,000 |
By Closing stock |
|
40,000 |
|
To Wages |
20,000 |
|
|
|
|
To Gross profit |
1,80,000 |
|
|
|
|
|
8,60,000 |
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|
8,60,000 |
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To Administrative expenses |
40,000 |
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|
1,80,000 |
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To Interest on loan |
10,000 |
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To Selling expenses |
20,000 |
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To Net profit |
1,10,000 |
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|
1,80,000 |
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|
1,80,000 |
Gross profit ratio (GPR)
= (Gross profit ÷ Net sales) x 100
= (180,000 ÷ 820,000) x 100
= 0.2195 x 100
= 21.95%
Net profit margin (NPM)
= (Net profit ÷ Net sales) x 100
= (110,000 ÷ 820,000) x 100
= 0.1314 x 100
= 13.41%
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Accounting Equation |
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Basic Journal Entries in Nepali |
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Basic Journal Entries |
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Journal Entry and Ledger |
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Ledger |
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Subsidiary Book |
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Cash Book |
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Trial Balance & Adjusted Trial Balance |
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Bank Reconciliation Statement (BRS) |
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Depreciation |
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Final Accounts: Class 11 |
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Adjustment in Final Accounts |
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Capital and Revenue |
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Single Entry System |
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Non-Trading Concern |
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Government Accounting |
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Goswara Voucher (Journal Voucher) |
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Operating Cost Ratio
Operation costs are daily, weekly, monthly and annual expenses of an organization.
Some operating costs are salary, rent, electricity bill, telephone bill etc.
Operation cost ratio is the relationship of cost of goods sold, administrative expenses, selling expenses and distribution expenses with sales.
Tax and interest are not included in operating cost.
Formula of operating cost ratio
Operating cost ratio = (Total operating expenses ÷ Total sales) x 100
Where:
Total operating cost = cost of goods sales + administrative expenses + selling expenses
PROBLEM: 4C
Following extracted information is given to you: ($/₹/Rs)
|
Sales |
6,00,000 |
|
Selling expenses |
70,000 |
|
Cost of goods sold |
3,00,000 |
|
Interest on loan |
10,000 |
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Administrative expenses |
90,000 |
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Required: (a) Operating cost ratio; (b) Administrative expenses ratio; (c) Selling expenses ratio
[Answer: OCA = 80%; AER = 15%; SER = 11.7%]
SOLUTION:
Given and working note:
Total operating cost
= Cost of goods sales + Administrative expenses + Selling and distribution expenses
= 3,00,000 + 90,000 + 70,000
= 4,80,000
Operating cost ratio (OCR)
= (Total operating expenses ÷ Total sales) x 100
= (480,000 ÷ 600,000) x 100
= 0.8 x 100
= 80%
Administrative expenses ratio (AER)
= (Administration expenses ÷ Total sales) x 100
= (90,000 ÷ 600,000) x 100
= 0.15 x 100
= 15%
Selling expenses ratio (SER)
= (Selling expenses ÷ Total sales) x 100
= (70,000 ÷ 600,000) x 100
= 0.117 x 100
= 11.7%
Return on Assets
It is also called profit to assets ratio.
Return is net profit after tax.
Company invests on assets to generate profit.
This ratio shows how efficiently management has utilized the total assets of the company.
Higher percentage efficiently used resources and vice versa.
Formula of return of capital employed
|
Return on assets |
= |
(Net profit after tax ÷ Total assets) x 100 |
|
Or |
= |
(Net profit after tax ÷ Average total assets) x 100 |
Where:
Average total assets = (opening assets + closing assets) ÷ 2
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4D
Following information is available: ($/₹/Rs)
|
Net profit after tax |
3,00,000 |
|
Interest on loan |
60,000 |
|
Fixed assets |
12,00,000 |
|
Current assets |
4,00,000 |
Required: Return on assets
[Answer: ROA = 22.5%]
SOLUTION:
Given and working note:
Total assets = fixed assets + current assets = 12,00,000 + 4,00,000 = Rs 16,00,000
Return on assets (ROA)
= (Net profit after tax ÷ Total assets) x 100
= (3,00,000 ÷ 16,00,000) x 100
= 0.1875 x 100
= 18.75%
Alternatively,
Return on assets (ROA)
= (Net profit after tax ÷ Total assets) x 100
= [(3,00,000 + 60,000) ÷ 16,00,000] x 100
= 0.2250 x 100
= 22.50%
Return on Capital Employed
Return is net profit after tax and capital employed is capital invested for buying fixed assets.
This ratio shows how to measure the return on shareholder’s investment.
It is most common ratio for fund measurement.
Equity shareholder gets remaining profit after charging outsider claim, preference dividend and reserve.
Higher percentage is better to company.
Formula of return on capital employed
Return on capital employed = (Net profit after tax ÷ Capital employed) x 100
Where:
Capital employed = Shareholders equity + Long-term debts
Capital employed = Fixed assets + Working capital
Working capital = Current assets – Current liabilities
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4E
Following information is given to you of XYZ Company Ltd:
|
Equity shares of Rs 100 |
16,00,000 |
|
8% Preference shares of Rs 100 |
8,00,000 |
|
10% Debentures |
6,00,000 |
|
Net profit after tax |
4,00,000 |
Required: Return on capital employed
[Answer: ROCE = 13.53%]
SOLUTION:
Given and working note:
Interest on debentures = 600,000@10% = 60,000
Return on capital employed (ROCE)
= (Net profit after tax ÷ Capital employed) x 100
= (400,000 ÷ 34,00,000) x 100
= 0.1176 x 100
= 11.76%
Return on Shareholder Equity
Return is net profit after tax and shareholders are permanent investor of the company.
This ratio shows how to measure the return on shareholder’s investment.
It is most common ratio for fund measurement.
Equity shareholder gets remaining profit after charging outsider claim, preference dividend and reserve.
Higher percentage is better to company.
Formula of return on shareholder’s equity
|
Return on shareholder’s equity (ROSE) |
= |
(NPAT ÷ Shareholders equity) x 100 |
|
Return on equity shareholder fund (ROESF) |
= |
(NPAT – Preference dividend ÷ Equity shareholders fund) x 100 |
Where:
Only equity shareholders fund = shareholders equity – preference shares
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4F
Following information is given by MC Company Ltd:
|
Equity shares of Rs 100 |
12,00,000 |
|
10% Preference shares |
8,00,000 |
|
Reserve and surplus |
220,000 |
|
Net profit after tax |
3,20,000 |
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Preliminary expenses |
20,000 |
|
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|
Required: (a) Return on shareholder equity (ROSE); (b) Return on equity shareholder fund
[Answer: ROSE = 14.55%; ROSE, only equity = 17.14%]
SOLUTION:
Given and working note:
|
Shareholder equity: |
Amount |
|
Common equity shareholders fund (CESF): |
|
Equity shares |
12,00,000 |
|
= Shareholders equity – preference shares |
|
Preference shares |
8,00,000 |
|
= 22,00,000 – 8,00,000 |
|
Reserve and surplus |
2,20,000 |
|
= 14,00,000 |
|
Less: Preliminary expenses |
(20,000 |
|
|
|
|
22,00,000 |
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|
Preference dividend (PD) = 800,000@10% = 80,000
Return on shareholder equity (ROSE)
= (NPAT ÷ Shareholders equity) x 100
= (320,000 ÷ 22,00,000) x 100
= 0.1455 x 100
= 14.55%
Return on equity shareholder fund (ROESF)
= [(NPAT – PD) ÷ Equity shareholders fund] x 100
= [(320,000 – 80,000) ÷ 14,00,000] x 100
= 0.1714 x 100
= 17.14%
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PROBLEMS AND ANSWERS |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4A
Following data are given to you: (amount is $/₹/Rs):
|
Purchased |
1,80,000 |
|
Sales |
4,70,000 |
|
Purchased return |
10,000 |
|
Sales return |
20,000 |
|
Administrative expenses |
27,000 |
|
Selling expenses |
22,000 |
|
Interest on loan |
18,000 |
|
Cost of goods sold |
2,30,000 |
Required: (a) Gross profit margin; (b) Net profit margin
[Answer: GPM = 48.89%; NPM = 34%]
*COGS = Net sales – Gross profit
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4B
Following data are given to you (amount is $/₹/Rs):
|
Gross profit |
1,80,000 |
|
Commission received |
20,000 |
|
Administrative expenses |
75,000 |
|
Selling expenses |
25,000 |
|
Interest on loan |
10,000 |
|
Sales for the period |
3,60,000 |
Required: (a) Gross profit ratio; (b) Net profit ratio
[Answer: GPR = 50%; NPR = 25%]
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4C
The following extracted data are taken from XYZ Company Ltd (amount in $/₹/Rs):
|
Equity shares capital |
5,00,000 |
|
General reserve |
50,000 |
|
15% Preference shares |
2,00,000 |
|
Net income before tax |
1,50,000 |
|
Discount on shares |
20,000 |
|
Tax rate on profit |
40% |
Required: (a) Return on shareholder equity (ROSE); (b) Return on equity shareholder fund (ROESF)
[Answer: ROSE = 12.33%; ROESF = 8.22%]
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country
PROBLEM: 4D
Extracted data are taken from XYZ Company Ltd (amount in $/₹/Rs):
|
Equity shares capital |
5,00,000 |
|
General reserve |
1,50,000 |
|
15% Preference shares |
3,00,000 |
|
12% Debentures |
2,00,000 |
|
Preliminary expenses |
40,000 |
|
Tax rate on profit |
40% |
|
Fixed assets |
9,00,000 |
|
|
|
Net profit before interest, tax and preference dividend 1,70,000
Required: (a) Return on shareholder equity (ROSE); (b) Return on equity shareholder fund (ROESF)
(c) Return on assets; (d) Return on capital employed
[Answer: ROSE = 9.63%; ROESF = 6.98%;
ROA = 10%; ROCE = 9.68%]
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