PROFITABILITY AND RETURN ON EQUITY OR ASSETS

Specific trades / industries. The sales figure is VAT exclusive. A high gross profit percentage does not result in a large (absolute) figure of gross profit.

It is given by:

$\frac{\text{Gross profit}}{\text{Sales}} \times 100$

Reflects the percentage of each shilling of net sales that becomes net operating profit / Net profit.

The sales figure is VAT exclusive.

It is calculated as:

$\text{Operating margin / Net profit ratio} = \frac{\text{Profit before interest and tax}}{\text{Net sales}} \times 100$

Or

$\frac{\text{Net operating income}}{\text{Net sales}} \times 100$

This ratio measures profit per value of net assets. The net assets figure is arrived at by using the following alternative formula:

• Capital employed = Fixed assets + current assets - current liabilities
• Capital employed = Total assets - current liabilities

It is given by the formula:

$\text{Return on capital employed} = \frac{\text{Profit before interest and tax}}{\text{Capital employed}} \times 100$

This ratio measures the ability of a firm in utilizing its total assets to generate profits.

It is given by the formula:

$\text{Return on total assets} = \frac{\text{Net profit}}{\text{Total assets}} \times 100$

This ratio measures the return earned by the company on each shillings of shareholders equity invested.

It is given by:

$\text{Return on owner's equity} = \frac{\text{Net profit}}{\text{Owner's equity}} \times 100$

---

Worked example

L Hope's business has a rate of stock turnover of 8 times per year. Average stock is £16,240. Mark-up is 60%. Expenses are 70% of gross profit.

You are to calculate:

1. Cost of goods sold.
2. Gross profit.
3. Turnover.
4. Total expenses.
5. Net profit.

Solution

1. Cost of goods sold = Stock turnover × Average stock = 8 × £16,240 = £129,920

2. Gross profit

Mark-up = 60% on cost

If cost = 100%, then sales = 160%

Gross profit = 60/100 × cost = 60/100 × £129,920 = £77,952

3. Turnover = Cost of goods sold + Gross profit = £129,920 + £77,952 = £207,872

4. Total expenses = 70% of gross profit = 70/100 × £77,952 = £54,566.40

5. Net profit = Gross profit - Total expenses = £77,952 - £54,566.40 = £23,385.60