14.CHAPTER 4 : RATIO ANALYSIS: PROFITABILITY RATIOS, GROSS PROFIT, OPERATING PROFIT RATIOS

LEARNING OUTCOMES:

INTRODUCTION

MEANING AND SIGNIFICANCE OF THE PROFITABILITY RATIOS

TYPES OF THE PROFITABILITY RATIOS:

1.GROSS PROFIT RATIO
2.OPERATING PROFIT RATIO:
FORMULA OF THE RATIOS

THE APPLICATION OF THE RATIOS
ITEMS OF THE NUMERATOR AND DENOMINATOR OF THE RATIO



INTRODUCTION AND GROSS PROFIT RATIO       (HEAR THE AUDIO CLIP)

Profitability ratios 

The profitability or financial performance is mainly summarised in the statement of profit and loss.
 Profitability ratios are calculated to analyse the earning capacity of the business which is the outcome of utilisation of resources employed in the business.
 There is a close relationship between the profit and efficiency with which the resources employed in the business are utilised. The various ratios which are commonly used to analyse the profitability of the business are:
1.Gross profit ratio
2. Operating profit ratio
3. Operating ratio
4. Net profit ratio
5. Return on investment (ROI) or Return on capital employed



1.Gross profit ratio   

As a percentage of revenue from operations is computed to have an idea about gross margin.

 It is computed = Gross profit divided by net revenue from operations × 100

Significance ..it indicates gross margin on product sold. It also indicates the margin available to cover operating expenses, non operating expenses etc.

Change in gross profit ratio may be due to change in selling price or cost of revenue from operations or a combination of both.
Low gross profit ratio may indicate unfavourable purchase and sales policy.

Higher gross profit ratio is always a good sign as it indicates higher gross margin on product sold.

Ques (EXAMPLE)

Following information is available for the year 2019-20, calculate gross profit ratio:
revenue from operations
cash                                 25000
credit                               75000
purchases:
Cash                               15000
credit                             60000
carriage inward               2000
Salaries                         25,000
decrease in inventory    10,000
return outwards                2000
wages                               5000

ANS.

Revenue from operations =cash revenue from operations + credit revenue from operation
=25000 + 75000 =1 lakh
Net purchases =cash purchases + credit purchases - return outwards
= 15000 + 60000 - 2000 = 73000

Cost of revenue from operations = opening inventory + net purchases + direct expenses - closing inventory

= net purchases + decrease in inventory (opening inventory - closing inventory +direct expenses (wages + carriage inward )

= 73000 + 10000 + (5000 + 2000) = 90000
Gross profit = Revenue from operations - Cost of revenue from operations
= 1 lakh - 90000 = 10,000
Therefore gross profit ratio

 = gross profit /revenue from operations x 100

 = 10000/100000 x 100
 = 10%

2.Operating profit ratio

OPERATING PROFIT RATIO    (HEAR THE CLIP)

 It is calculated to reveal operating margin.

 It is calculated as =
Operating profit divided by Revenue from operations ×100

*If Gross profit is given in the question then 

*Operating profit = Gross profit - Operating Expenses + Operating Incomes 

Alternatively if Net profit is given in the question then 

Operating profit = Net profit before tax - Non operating income tax + Non operating expenses 

where 

*Operating expenses = office expenses, administrative expenses, selling expenses, distribution expenses, depreciation and amortization expenses, employee benefit expenses

* Operating income = commission received, royalty received etc.

* Non operating expenses = loss by fire / accidental loss, loss on sale of non current assets, interest on long term debts paid, bank charges, etc.

* Non operating incomes = interest received, rent received, dividend received, profit on sale of non current assets, speculation gain, etc.

Significance of Operating profit ratio helps to analyse the performance of Business and throws light on the operational efficiency of the business it is very useful for inter firm as well as intra firm comparisons.

Ques (EXAMPLE)

Calculate operating profit ratio
net profit (before tax)                                   150000
finance cost                                                   10,000
loss on sale of tangible fixed assets                 5000
rent received                                                  12000
interest received on investment                      3000

commission received                                     2,000
revenue from operations                             500000.

ANS.

Operating profit ratio = Operating profit/ Revenue from operations x 100
Operating profit = Net profit (before tax) + Non operating expenses - Non operating income
= Net profit before tax + (finance cost + loss on sale of fixed tangible asset) - (rent received + interest received on investment)
= 150000 + (10000 + 5000) - (12000 + 3000)
= 150000 + 15000 - 15000 = 150000
Revenue from operations = 5 lakh
Therefore, operating profit ratio

 = 150000/500000
 = 30% 


CONCLUDING NOTE: 

PLEASE GO THROUGH THE EXPLANATION OF THE FORMULAS,
EXAMPLES FOR CLARITY.