Question

Write a paper on one of the four building blocks of financial ratios on Profit margin rate, Gross Profit Margin rate, Return on assets ratio (ROA), Return on equity (ROE), and Basic earnings per share? How each of the ratios is calculated and used to analyze financial statements? And also apply these ratios on A recently filed set of financial statements for Walmart Inc. ?

 

 

Answer 1

1.

a. Profit margin rate

The profit margin rate compares profit to sales and indicates how well a company is handling its finances overall. The rate shows the percentage of revenue that the company keeps as gross profit and is always expressed as a percentage. Generally, a good rate tends to range from 6% to 11%.

 

b. Gross Profit Margin rate

The gross profit margin is generally a measure to show how much revenue a business retains after subtracting its cost of goods sold. Therefore, the profit margin rate compares profit to sales and indicates how well a company is handling its finances. A higher gross margin rate implies that a company is being operated more efficiently and hence is more stable financially. On the other hand, a lower rate means that a company is not being managed efficiently and is likely to be financially unstable. Overall, this rate acts as a measure of a company’s profitability (Abdul Rahman, 2017).

 

c. Return on assets ratio (ROA)

Return on assets indicates the percentage of net earnings compared to a company’s total assets. It also reveals how well those assets generate value. Generally, it is a significant measure of productivity and profitability a company. As a rule, the higher the rate, the better because it shows that a company is managing its assets efficiently in order to produce more net profits.

This ratio is useful to investors and other stakeholders in assessing a company's financial strength and efficiency in using resources.

 

d. Return on equity (ROE)

Return on equity expresses the rate of return on the capital that investors have invested in a company. It is a profitability ratio that measures the ability of a company to generate profits from shareholders investments. In other words, the ratio reveals how much profit each dollar of common stockholders' equity generates. In most cases, it aids investors in understanding whether they're getting a good return on their investments. Finally it’s a good way to evaluate the efficiency of a company in utilizing its equity.

 

A higher percentage of return on equity indicates that a company is effective in generating profit from its assets.

 

e. Basic earnings per share

Basic earnings per share is a measure that shows the amount of a company's profit that can be allocated to a share of its common stock. Basically, it measures the amount of a company's profit on a per-share basis. It is one of the most critical measures for determining a company’s profitability on an absolute basis. (Aulová et al., 2019)

 

2.

Profit margin rate

1. First, you calculate net sales

Net sales = revenue – (returns, refunds and discounts)

2. Secondly, you determine net income

Net income = revenue - expenses

3. Finally, you calculate the profit margin ratio

Profit margin = (net income / net sales) x 100

 

Its use:

The profit margin rate provides a measurement of the amount of profits generated from a company's sales. This rate is crucial in determining how a company’s finances are utilized.

 

Gross margin rate

Steps for calculating it:

1. Net sales = revenue – (returns, refunds and discounts)

2. Gross margin = net sales - cost of goods sold

3. Gross margin rate = ((Net sales – cost of goods sold)/net sales) X 100

 

Its use:

The gross profit margin rate acts as a measurement of how efficiently a company generates money from selling its products and services. And because it measures profit as a percentage of sales revenue, it is normally utilized for comparing the performances of different companies with different sales revenues.

 

Return on total assets ratio

The return on total assets ratio is calculated by dividing a company's Net Income by its average total assets and then multiplying the result by 100%.

 

Return on total assets ratio =

(Net Income/((Total assets for the current year + Total assets for the previous year)/2)) x 100

 

Its use:

The return on assets ratio measures how efficiently a company is earning profits from the assets on their balance sheet. In other words, it indicates how well a company's investments generate value for its investors.

 

Return on equity ratio

The return on total equity ratio is calculated by dividing a company's Net Income by its average total equity and then multiplying the result by 100%.

 

Return on total equity ratio =

(Net Income/((Total equity for the current year + Total equity for the previous year)/2)) x 100

 

Its use:

Return on total equity ratio measures a company's ability to generate profits from its shareholders' investments or equity. This profitability aids is assessing a company's effectiveness in using equity funding. A high Return on total equity ratio means that a company is increasing its profit generation without needing more funding.

 

Basic earnings per share

How it is calculated:

Basic Earnings per Share = (Net income - preferred dividends)/weighted average of common shares outstanding during the period.

 

Its use:

Basic earnings per share indicates to investors how much of a company's net income was allocated to each share of common stock. The higher it is, the more profitable a company is.(Tissen & Sneidere, 2019)

 

3. A recently filed set of financial statements for Walmart Inc.

 

The data is from Walmart Inc. 2021 Annual Financial Reports

 

Profit margin rate = Net income/Net sales

Net Income = $13,510

Net sales = $555,233

Profit margin = $13,510/$555233

2.4322%

 

Gross Margin rate = (Net sales- Cost of goods sold)/Net sales

Net sales = $555,233

Cost of goods sold = $420,315

Gross Margin rate = ($555,233 - $420,315)/$555,233

24.299%

 

Return on Total Assets = Net Income/Average total assets

Net Income = $13,510

Total assets for 2020 = $236,495

Total assets for 2021 = $252,496

Average total assets = (Total assets for 2020 + Total assets for 2021)/2

$ 244,495.50

 

Return on Equity = Net Income/Average total equity

Net Income = $13,510

Total equity for 2020 = $81,552

Total equity for 2020 = $87,531

Average total equity = (Total equity for 2020 + Total equity for 2021)/2

$ 84,541.50

 

Basic Earnings per share = (Net Income – Preferred dividends)/Weighted average Common shares outstanding.

 

Basic EPS for Walmart = $2,831

Note: Walmart did not indicate or separate dividend amounts for common shareholders and preferred shareholders. Hence, the Basic EPS above was not calculated but only recorded as shown on page 54 of the attached Walmart’s Annual Financial Report 2021.(Corporate Walmart, 2021)

Return on total equity ratio =

(Net Income/((Total equity for the current year + Total equity for the previous year)/2)) x 100