Financial ratios are tools used by company management in assessing the effectiveness of company performance in one period. Financial ratios are also used as an evaluation tool to further enhance the company’s subsequent performance. Basically, financial ratios consist of four parts, namely financial liquidity ratios, activity ratios, solvency ratios and profitability ratios. In this article, we will discuss more about profitability ratios.
Profitability Ratios ( Profitability Ratio ) is the ratio to determine a company’s ability to earn income ( profit ) of income ( earnings ) related to the sale of assets and equity based on specific measurement basis. Types of profitability ratios are used to show how much profit or profit derived from the performance of a company that affects the records of financial statements that must be in accordance with financial accounting standards.
Profitability Ratio Function
Profitability ratios needed to record financial transactions are usually assessed by investors and creditors (banks) to assess the amount of investment profit to be obtained by investors and the amount of corporate profits to assess the company’s ability to pay debts to creditors based on the level of use of assets and other resources so that it looks level of company efficiency.
The effectiveness and efficiency of management can be seen from the profits generated against the company’s sales and investments as seen from the elements of the financial statements. The higher the value of the ratio, the better the company’s condition based on profitability ratios. High value symbolizes the level of profit and high company efficiency that can be seen from the level of income and cash flow. Profitability ratios provide important information than the previous period’s ratios and competitor achievement ratios.
Thus, an analysis of industry trends is needed to draw useful conclusions about a company’s profitability. Profitability ratios reveal the final results of all financial policies and operational decisions made by the management of a company in which the petty cash recording system is also influential.
Types of Profitability Ratios
Profitability ratios are divided into seven types namely gross margin (GPM), profit margin ratio (PMR), net profit margin (NPM), operating ratio (OR), e arning power of total investment (EPTI), return of investment (ROI), own capital profitability (RMS). Several types of profitability ratios that are often used to review a company’s ability to generate profits that are used in types of financial accounting include:
a. Gross Profit Margin ( Gross Profit Margin )
Gross profit margin is the ratio of profitability to assess the percentage of gross profit to revenue generated from sales. Gross profit affected by the cash flow statement describes the amount of profit obtained by the company with consideration of the costs used to produce products or services.
This Gross Profit Margin is often referred to as the Gross Margin Ratio . Gross profit margin measures the efficiency of calculation of cost of goods or production costs. The greater the gross profit margin, the better (efficient) the company’s operational activities which show the cost of goods sold is lower than sales ( sales ) which is useful for operational audits. If on the contrary, the company is not good in conducting operational activities. The formula for calculating gross profit is as follows.
| Gross Profit Margin = (gross profit / total income) x 100% |
Example:
PT Megah Sejahtera’s gross profit: Rp.48,000,000
Total company revenue: IDR 55,000,000
Then the Gross Profit Margin of the company PT Megah Sejahtera = (Gross Profit: Total Revenue) x 100%
= (48,000,000: 55,000,000) x 100%
= 87%
b. Net Profit Margin ( Net Profit Margin )
Net profit margin is a profitability ratio to assess the percentage of net profit earned after deducting taxes from the income derived from sales. This net profit margin is also called the profit margin ratio . This ratio measures the net profit after tax against sales. The higher the net profit margin the better the operation of a company. Net profit margin is calculated using the following formula.
| Net Profit Margin = Net Profit After Tax: Sales |
Example:
Net Sales Revenue ( Net Sales ) = Rp27.063.310.000.000.
Net Profit after Tax ( Net Profit after Tax ) = Rp2,064,650,000,000.
Net Profit Margin ( Net Profit Margin ): ??
Answer:
Net Profit Margin = Net Profit after Tax: Net Sales Revenue
Net Profit Margin = Rp2,064,650,000,000: Rp27,063,310,000,000
Net Profit Margin = 7.63%
c. Ratios Return on Assets ( Return on Assets Ratio )
The rate of return of assets is the profitability ratio to assess the percentage of profits (profits) obtained by the company related to resources or total assets so that the efficiency of a company in managing its assets can be seen from this percentage ratio. The Asset Return Ratio formula is as follows.
| ROA = Net Profit: Total Assets |
Example calculation of ROA by using a company’s financial statement data. Note: the company’s net profit is IDR 180,000,000 and total assets are IDR 20,000,000, then calculate the company’s ROA.
ROA = Net Profit: Total Assets
ROA = 180,000,000: 20,000,000,000 = 9%
d. Ratios Return on Equity ( Return on Equity Ratio )
Return on Equity Ratio (ROE) is a profitability ratio to assess the company’s ability to generate profits from the investment of the company’s shareholders expressed as a percentage. ROE is calculated from the income of the company against the capital invested by the owners of the company (ordinary shareholders and preferred shareholders). Return on equity shows how successfully the company manages its capital (net worth), so that the level of profit is measured by the investment of the capital owner or the company’s shareholders. ROE is the profitability of own capital or so-called business profitability. The Return On Equity formula is as follows.
| ROE = Net Income After Tax: Shareholders’ Equity |
Example:
Based on the financial statements issued as of December 31, 2017, PT Megah Sejahtera which is engaged in the construction sector has a net profit after tax of Rp500 million, the total equity of the shareholders is as much as Rp800 million. What is the PT Megah Sejahtera Return on Equity (ROE) ratio?
ROE = Net profit after tax: Shareholder equity
ROE = IDR 500,000,000: IDR 800,000,000
ROE = 62.5%
e. Ratios Return on Sales ( Return on Sales Ratio )
Return on Sales is a profitability ratio that shows the level of profit of the company after payment of variable costs of production such as labor costs, raw materials, etc. before deducting taxes and interest. This ratio shows the level of profit obtained from each selling rupiah which is also called the operating margin or operating income margin . Following is the formula for calculating return on sales (ROS).
| ROS = (Profit before Tax and Interest / Sales) x 100% |
Example:
PT Megah Sejahtera generated a Profit before Tax and Interest of Rp100 million while Sales amounted to Rp1.5 billion. What is the Return on Sales or PT Megah Sejahtera Sales Returns?
Answer:
ROS = (Profit before Tax and Interest: Sales) x 100%
ROS = (IDR 100,000,000: IDR 1,500,000,000) x 100%
ROS = 6.7%
f. Return on Capital used ( Return on Capital Employed )
Return on Capital Employed (ROCE) is a profitability ratio that measures a company’s profit from the capital used as a percentage (%). The capital in question is the company’s equity plus non-current liabilities or total assets less current liabilities. ROCE reflects the efficiency and profitability of a company’s capital or investment. Profit before tax and interest reduction is known as “EBIT”, namely Earning Before Interest and Tax. The following 2 ROCE formulas are often used.
| ROCE = Profit Before Tax and Interest / Working Capital
or ROCE = Profit Before Tax and Interest / (Total Assets – Liabilities) |
g. Return on Investment (ROI)
Return on investment is the profitability ratio calculated from net income after deducting taxes from total assets. Return on investment is useful to measure the overall ability of the company to generate profits against the total assets available in the company. The higher this ratio means the better condition of a company. The following Return on Investment formula .
| ROI = ((Return on Investment – Initial Investment) / Investment) x 100% |
Example:
The Forward Forward Company invested IDR 500,000,000 in a vehicle product sales business. The Forward Forward Company turned out to get sales of 1,000 vehicles. And from the sale the company made a profit of Rp. 600,000,000.
Note: investment return (profit) of IDR 100,000,000
And initial capital (investment) of IDR 500,000,000
So the calculation is obtained as follows.
ROI = (IDR 600 million – IDR 500 million): IDR 500 million) x 100 = 20%
So the ROI is 20%
h. Earning Per Share (EPS)
Earning per share is a profitability ratio that assesses the level of ability per share in generating profits for a company. Company management, ordinary shareholders and prospective shareholders are very concerned about earnings per share because it is an indicator of company success. The earnings per share formula is as follows.
| EPS = Net Income After Tax – Preferred Stock Dividend / Number of Outstanding Common Shares |
Example:
The Setia Merdeka Company has 1 million shares outstanding in 2017, net profit after tax is Rp1 billion. The Setia Merdeka Company then decided to distribute 10% dividends or around Rp100 million to its shareholders. What is Earning Per Share (EPS) or Earnings per share?
Earnings per Share (EPS) = (Net Profit after Tax – Dividends): Number of Shares Outstanding
Earnings per Share (EPS) = (1,000,000,000 – Rp 100,000,000): 1,000,000
Earnings per Share (EPS) = 900,000,000: 1,000,000
Earnings per Share (EPS) = 900, –
So PT Setia Merdeka’s Earnings per Share (EPS) is Rp900.
