Question

Illustrate measures of profitability and efficiency that are important to the entrepreneur and equity investors.

Answer 1

Measures of Profitability:

(1): Net profit Ratio- This ratio tells the relationship between Net profit and sales. Net profit is the actual profit that company gets after subtracting all the expenditures from revenue.

Net profit ratio = Net profit / Sales

(2): Return on Assets- This ratio is the relationship between Net profit and total assets of the company. This ratio tells how efficiently company is using its assets to generate the profit.

Return on Assets = Net profit / Total Assets

(3): Return on Equity- This ratio is the relationship between Net profit and shareholder's fund. This ratio tells how much shareholders get after investing their equity.

Return on Equity = Net profit / Shareholder's fund

Efficiency Measures-

(1): Asset turnover ratio- This ratio tells how efficiently company is using its assets to generate sales. This is the relationship between total assets of the company and sales.

Asset turnover ratio = Net Sales / Average total assets

(2): Inventory turnover ratio- This ratio tells how many times, company's inventory is sold in a particular period. This ratio is the relationship between cost of goods sold and average inventory.

Inventory turnover ratio = COGS / Average Inventory

(3): Receivable turnover ratio- This ratio tells how early/late company, collects the payment. If company collects the payment in less time, it is good.

Receivable turnover ratio = Net Sales / Average account receivables