Question

A. How do you calculate net profit starting with sales? What is the difference between two ventures if one has very low net profit margin and the other with high profit margin? Is the difference attributed to management of costs and expenses? If yes, why?

B. How is ROA related to Net Profit Margin and asset turnover?

Answer 1

A.

Total sales or cash revenue

Less: Cost of goods sold

Gross profit

Less: Operating expenses

Salaries

Rent

Utilities

Depreciation

EBIT

Less: Interest expenses

Less: Income taxes

Net Profit

Yes, low or high profit margin can be attributed to expense management.

Low Profit Margin Company sells its product or service which is close to the cost of acquiring and maintaining the product whereas company with high profit margin sells its product in a price which is much more than the cost related to obtain and retain the product.

B.

Return on asset ratio = Net income/ Average total assets

                                  = (Net income /net sales) x (net sales/ Average total assets)

                                  = Profit margin x Asset turnover

So Return on asset can be represented as a product of the profit margin and total asset turnover.