Continued from my last article, we now look at the financial ratio for assessing the profitability of a company.
This type of financial ratio should be able to measure the bottom-line results or the profitability of the company.
One typical major Profitability ratio is:
The GROSS PROFIT MARGIN
Gross Profit / Net Sales
Profitability of trading and mark-up
SCORE OR VALUE
15-25% for supermarkets
#90 % for software industry
20-30% is OK
SALIENT POINTS TO NOTE:
1.Must be compared to industry averages and theÂ Â trend over time
2. High gross margin means a lot of money left over to spend on other business operations such as research & development or marketing.
3. If GPM is on downwards trends, might be a tell tale sign of future problems facing the bottom line [when labor and material costs increase rapidly, likely to lower gross profit margins-unless company pass these costs to customers in the form of higher selling prices
4. The results may skew if the company has a very large range of products
5. An increase in this ratio might indicate the following:
· Increase in selling price without corresponding increase in cost,
· Decrease in costs not reflected in the selling price or a decrease in selling price with the same amount of gross profit,
· Opening stock valued at a smaller figure,
· Invoices for purchases being omitted,
· Consignment stocks being recognize as sales,
· Sales being over-recognize despite work has not been done,
· Closing stock valued too high
6. A decrease in this ratio might indicate the following:
· Decrease in selling price without corresponding decrease in cost,
· Increase in costs without a corresponding increase in the selling price,
· Closing stock being undervalued,
· Omission of closing stock
· Third party goods including proprietors including in the purchases account,
· Stocks being misappropriated.