Question

Explain what is the limitation of the Profit Margin On Sales and explain the limitation of return on assets.

Answer 1

Meaning of profit margin on sales It is the financial which is used to calculate profit on the basis of sale. In this the profit of the firm is depend upon the volume of sales and the percentage of profit margin on sales.

Limitations of profit margin on sales are as follows

1. When the Profit Margin On Sales is calculated we commonly compare the figures of the company with the similar company. it is not always be possible that profit mrgin always be same of related companies.

2. When we calculate profit with Profit Margin On Sales we not considered assets of the company.

3. If the company have more debt financiang having high interest expense which negatively affect the net profit of the company.

4. It is very difficult to estimate the Profit Margin On Sales & A wrong expectations may be very costly for the company.

Return on Assets

It the financial Ratio that show the ability of the firm that it make effective use of its assets.

Formula of ROA is = EBIT/Total assets

Limitations of return of assets are follows

1. In this ratio there is lack of clearity in calculation some of the company use net profit and some uses net earning before interest and taxes. So there are lack of confidentiality in this ratio

2. This ratio is not usefull for capital intensive and service-based  companies. Service based companies not need much more assets so their ROA is very high And in capital intensive companies ROA is very low.