Profitable Ratio Analysis
Ratio analysis is finding the relation between the two variables taken from the financial statement. The ability of a business to earn income is called profitability. Profitability ratios focus primarily on:
- The relationship between operating results as reported in the income statement
- Resources available to the business as reported in the financial statements
The ability of a business to earn profits depends on the effectiveness and efficiency of its operations, as well as the resources available to it. One such profitability ratio is return on sales. This represents the relation between sales dollars and profit / Net Income dollars.
Profitability ratio on sales =
| Net Income |
| Sales |
Example:
Part 1:
Calculate the profitability ratio when net income in the year is $40,000 and sales total $100,000.
Profitability ratio on sales =
| Net Income |
|
| Sales |
|
| = 40,000 | = 0.40 or 40% |
| 100,000 |
Part 2:
Calculate the profitability ratio for the next year and compare to check the increase or decrease in percentage when net income in the next year is $50,000 and sales total $100,000.
Profitability ratio on sales =
| Net Income |
|
| Sales |
|
| = 50,000 | = 0.50 or 50% |
| 100,000 |
You can see that profit per sales dollar increases by 10% in the next year, compared to that of the first year.