Profitability and Coverage Analysis
4. Table of profitability financial ratios, formulas and interpretation
All profitability ratios which we discussed in this tutorial are summarized in the table below:
PROFITABILITY
RATIOS |
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RATIO |
FORMULA |
APPLICABILITY |
Return on Sales (ROS) |
Operating Profit ÷ Total Sales |
Measures how much profit a company generates per dollar of sales. |
Important |
When evaluating and analyzing the return on sales, it is important to consider the following factors:
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Return on Assets (ROA) |
Net Profit before Taxes ÷ Total Assets |
Measures how effectively a company utilizes assets available to generate profits. |
Important |
The following factors should be taken into account, when evaluating ROA ratio:
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Return on Equity (ROE) |
Net Income (after Taxes) ÷ Average Shareholder's equity |
Measures how effectively a company employs resources provided by owners (i.e., shareholder’s equity) in generating earnings. |
Important |
The return on equity ratio can be a misleading measure of profitability in some circumstances:
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Return on Investment (ROI) |
(Gain from Investment – Cost of Investment) ÷ Cost of Investment |
Evaluates the profitability of an investment in relation to the invested capital. |
Important |
When evaluating the return on investment ratio, it is important to consider the following factors:
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Return on |
Income before Taxes ÷ Capital Employed |
Measures how efficiency and profitably a business operates with the capital employed. |
Important |
One of the limitations of return on capital employed is the fact that it does not account for the depreciation and amortization of the capital employed. Because capital employed is in the denominator, a company with depreciated assets (e.g., an older company) may find its ROCE increase without an actual increase in profit. |
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Earnings before Interest and Taxes (EBIT) |
Revenue – Cost of Goods Sold – Operating Expenses + Non-operating Income |
An indicator of a company’s profitability before interest and income tax expenses. |
Important |
If the company does not have non-operating income, EBIT is also called operating profit because it shows a company’s earnings from ordinary operations. |
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EBITDA |
EBIT + |
An indicator of company’s profitability before interest, income tax expenses, depreciation and amortization. |
Important |
EBITDA is a non-GAAP (Generally Accepted Accounting Principles) measure of profitability. It can be a misleading measure of profitability in many circumstances, for example:
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