This series follows the series about Group of financial analysis indicators and describes in detail the indicators of profitability.
Profitability is defined as the ability to achieve profit by using various resources.
Profitability indicators form one group of financial analysis, which are used to evaluate profitability and efficiency of the company management, i.e. the company's ability to produce maximum output (i.e. margin or profit), ideally with minimal inputs.
Group of profitability indicators includes the following indicators:
Gross margin is one of profitability indicators.
Net margin (Return On Revenue - ROR" or Return On Sales - ROS ") is one of profitability indicators. It shows how much profit is generated from the unit revenue. It is a useful indicator to control costs as the formula for operating ratio can be easily derived from it.
Profit may be EBIT (PBIT), EBT (PBT) or EAT (PAT).
Value added (VA) is one of profitability differential indicators and it shows the value that the entity has added to external inputs. Value added is obtained as a difference between revenues from sales of goods/services and costs for inputs (usually direct costs).
There are two alternatives for value added:
Economic Value Added (EVA) evaluates the value (profit) generated by the company during the year in excess of the cost of capital.
NOPAT - (invested capital * WACC)
Explanation of terms:
• NOPAT →Net Operating Profit After Tax (Operating profit after taxes)
• invested capital → total equity and liabilities
• WACC →Weighted Average Cost of Capital, which must be calculated as well
Market value added (MVA) shows how much value the company delivers to its shareholders. Unlike EVA, MVA evaluates the long-term development and the contribution is evaluated over the entire life of the company (not per year). MVA is used to assess the quality of management work.
market value of the company - the amount of capital invested
Return on capital employed (ROCE) is one of profitability indicators and it indicates how efficiently the company manages its long-term resources, i.e. how much profit will be generated by the unit of the long-term investment.
As the result, ROCE provides better information than ROE, because ROE has in the denominator only equity and as such does not consider the amount of loans (i.e. long-term liabilities).
* can be in the form of average of the start and end of the period
Profit in the numerator is mostly EBIT, but can be also EBT, EAT, Net income or Net income less the interest on long-term loans.
Return on equity (ROE) is one of profitability indicators, which shows how effectively the entity manages resources invested by the shareholders/partners.
* can be in the form of average of the beginning and end of the period
The numerator is most often EAT (PAT), often after deduction of dividends to owners of preferred shares.
If the entity is financed only by equity, the ROE can be consistent with ROCE.
Comparison with other companies makes sense only within the same industry. It is appropriate to look to the trend development over a longer period of time.
Recommended value depends on many factors (e.g. industry or macro-economic developments), however, it should be over 12% in stable economies (11).
is that it does not take into account loans (or rather liabilities), so the reason for good ROE can also be higher indebtedness (especially in the case of cheaper loans). Because of this, ROE is mainly used by shareholders (it makes more sense to use ROCE internally) and debt ratios shall be analyzed parallel as well.
Return on assets (ROA) is one of profitability indicators reveals how much profit will be generated by unit of assets. It expresses how effectively the company manages its assets.
* often average from the beginning and ending balance
The numerator is usually EAT (PAT) or EBIT.
The higher is the net margin and the higher asset turnover, the higher is ROA.
ROA is usually lower in companies with naturally high asset (e.g. utilities). Conversely, companies with low assets (e.g. services) tend to have higher ROA.
Recommended value: Wikipedia states that ROA above 5% is considered good (12).
Operating ratio is one of profitability indicators. Its formula can be easily derived from the profit margin formula (Return on sales). It expresses how much cost is incurred for each unit of sales.
Return on costs (ROC) is one of profitability indicators. It expresses the amount of profit attributable to unit total cost.