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
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FORMULA |
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Gross Profit / Net Sales |
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MEASURE WHAT |
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Profitability of trading and mark-up |
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SCORE OR VALUE |
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Varies. 15-25% for supermarkets #90 % for software industry 20-30% is OK |
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SALIENT POINTS TO NOTE: |
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1.Must be compared to industry averages and the  trend over time |
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2. High gross margin means a lot of money left over to spend on other business operations such as research & development or marketing. |
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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 |
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4. The results may skew if the company has a very large range of products |
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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 |
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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. |
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