Question

a) Please describe in detail what PROFITABILITY RATIO attempt to measure?

b) Where would you obtain such information?

c) For what period of time and what other comparisons would assist your analysis.

d) What management policies would have a positive affect on this analysis tool?

Please do part B-D

Answer 1

a) Please describe in detail what PROFITABILITY RATIO attempt to measure?

Answer: Profitability ratio attempts to measure the effect of profitability of a company by measuring the revenues with income. It is used to assess the ability of the business to generate profits as compared to the cost incurred to obtain the profit. Profitability ratios are compared with previous periods to measure the increment or decreasein profitability, also it is compared with the benchmarks or industry to judge whether the profit earning capability of the firm is competitive enough. Gross profit margin, net profit margin, return on assets, return on equity etc. are the most common ratios.

b) Where would you obtain such information?

Answer: The informations required for calculating profitability ratios can be found in Income statement, which gives the revenue, gross profit, net profit, and also the expenses. Some informations like total assets, total equity capital etc can be found in Balance Sheet. Financial statements are the main source of information for profitability ratios.

c) For what period of time and what other comparisons would assist your analysis.

Generally the profitability ratios are measured from the financial statements of one financial year. And compared with industry or benchmarks in the same financial year. However in order to catch the trend of the profitability ratios, yearly raios could be calculated and compared with past historical data.

d) What management policies would have a positive affect on this analysis tool?

The company may adopt the following policies which could improve profitability ratios;

• Reduce Cost: the company should compare the profitability ratios with industry and make sure to reduce the unnecessary expenses could be identified and measures to be taken to control it.
• Analyse the past information: The company could use historical financial information to compare and understand the financial statements in a much better way. Thus identifying the areas which is area of concern and try to control the cost and improve take management decision for improving in future.
• Future Decision Making: The past informations analysed with the help of profitability ratios help management to formulate policies whether to go for expansion or not. Whether to go for 'make or buy decision'. Whether to continue or discontinue a product line, etc.