- Gross Profit Ratio: Gross Profit Ratio shows the relationship
between Gross Profit of the concern and its Net Sales. Gross Profit
Ratio can be calculated in the following manner: -
Gross Profit Ratio = Gross Profit/Net Sales
x 100
Where Gross Profit = Net Sales – Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses
– Closing Stock
And Net Sales = Total Sales – Sales Return
Objective and Significance: Gross Profit Ratio provides
guidelines to the concern whether it is earning sufficient profit
to cover administration and marketing expenses and is able to
cover its fixed expenses. The gross profit ratio of current year
is compared to previous years’ ratios or it is compared with the
ratios of the other concerns. The minor change in the ratio from
year to year may be ignored but in case there is big change, it
must be investigated. This investigation will be helpful to know
about any departure from the standard mark-up and would indicate
losses on account of theft, damage, bad stock system, bad sales
policies and other such reasons.
However it is desirable that this ratio must be high and steady
because any fall in it would put the management in difficulty
in the realisation of fixed expenses of the business.
- Net Profit Ratio: Net Profit Ratio shows the relationship
between Net Profit of the concern and Its Net Sales. Net Profit
Ratio can be calculated in the following manner: -
Net Profit Ratio = Net Profit/Net Sales x 100
Where Net Profit = Gross Profit – Selling and Distribution Expenses
– Office and Administration Expenses – Financial Expenses – Non
Operating Expenses + Non Operating Incomes.
And Net Sales = Total Sales – Sales Return
Objective and Significance: In order to work out overall
efficiency of the concern Net Profit ratio is calculated. This
ratio is helpful to determine the operational ability of the concern.
While comparing the ratio to previous years’ ratios, the increment
shows the efficiency of the concern.
- Operating Profit Ratio: Operating Profit means profit
earned by the concern from its business operation and not from
the other sources. While calculating the net profit of the concern
all incomes either they are not part of the business operation
like Rent from tenants, Interest on Investment etc. are added
and all non-operating expenses are deducted. So, while calculating
operating profit these all are ignored and the concern comes to
know about its business income from its business operations.
Operating Profit Ratio shows the relationship between Operating
Profit and Net Sales. Operating Profit Ratio can be calculated
in the following manner: -
Operating Profit Ratio = Operating Profit/Net
Sales x 100
Where Operating Profit = Gross Profit – Operating Expenses
Or Operating Profit = Net Profit + Non Operating Expenses – Non
Operating Incomes
And Net Sales = Total Sales – Sales Return
Objective and Significance: Operating Profit Ratio indicates
the earning capacity of the concern on the basis of its business
operations and not from earning from the other sources. It shows
whether the business is able to stand in the market or not.
- Operating Ratio: Operating Ratio matches the operating
cost to the net sales of the business. Operating Cost means Cost
of goods sold plus Operating Expenses.
Operating Ratio = Operating Cost/Net Sales
x 100
Where Operating Cost = Cost of goods sold + Operating Expenses
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses
– Closing Stock
Operating Expenses = Selling and Distribution Expenses, Office
and Administration Expenses, Repair and Maintenance.
Objective and Significance: Operating Ratio is calculated
in order to calculate the operating efficiency of the concern.
As this ratio indicates about the percentage of operating cost
to the net sales, so it is better for a concern to have this ratio
in less percentage. The less percentage of cost means higher margin
to earn profit.
- Return on Investment or Return on Capital Employed: This
ratio shows the relationship between the profit earned before
interest and tax and the capital employed to earn such profit.
Return on Capital Employed
= Net Profit before Interest, Tax and Dividend/Capital Employed
x 100
Where Capital Employed = Share Capital (Equity + Preference)
+ Reserves and Surplus + Long-term Loans – Fictitious Assets
Or
Capital Employed = Fixed Assets + Current Assets – Current Liabilities
Objective and Significance: Return on capital employed
measures the profit, which a firm earns on investing a unit of
capital. The profit being the net result of all operations, the
return on capital expresses all efficiencies and inefficiencies
of a business. This ratio has a great importance to the shareholders
and investors and also to management. To shareholders it indicates
how much their capital is earning and to the management as to
how efficiently it has been working. This ratio influences the
market price of the shares. The higher the ratio, the better it
is.
- Return on Equity: Return on equity is also known as return
on shareholders’ investment. The ratio establishes relationship
between profit available to equity shareholders with equity shareholders’
funds.
Return on Equity
= Net Profit after Interest, Tax and Preference Dividend/Equity
Shareholders’ Funds x 100
Where Equity Shareholders’ Funds = Equity Share Capital + Reserves
and Surplus – Fictitious Assets
Objective and Significance: Return on Equity judges the
profitability from the point of view of equity shareholders. This
ratio has great interest to equity shareholders. The return on
equity measures the profitability of equity funds invested in
the firm. The investors favour the company with higher ROE.
- Earning Per Share: Earning per share is calculated by
dividing the net profit (after interest, tax and preference dividend)
by the number of equity shares.