Thursday, January 27, 2011

How to Financial Reports for Profitability Ratios

You read financial reports to get a sense of a company’s financial position and how viable it is in the marketplace. You can test a company’s money-making prowess by using the following important formulas:

·  Price/earnings ratio compares the price of a stock to its earnings. A ratio of 10 means that for every $1 in company earnings per share, people are willing to pay $10 per share to buy the stock.
Price/earnings ratio = Market value per share of stock ÷ Earnings per share of stock
· Dividend payout ratio shows the amount of a company’s earnings that are paid out to investors. Use it to determine the actual cash return you get by buying and holding a share of stock.
Dividend payout ratio = Yearly dividend per share ÷ Earnings per share
·  Return on sales tests how efficiently a company is running its operations by measuring the profit produced per dollar of sales.
Return on sales = Net income before taxes ÷ Sales

·  Return on assets shows you how well a company uses its assets. A high return on assets usually means the company is managing its assets well.
Return on assets = Net income ÷ Total assets
· Return on equity measures how well a company earns money for its investors.
Return on equity = Net income ÷ Shareholders’ equity

· The gross margin gives you a picture of how much revenue is left after all the direct costs of producing and selling the product have been subtracted.
Gross margin = Gross profit ÷ Net sales or revenues

· The operating margin looks at how well a company controls costs, factoring in any expenses not directly related to the production and sales of a particular product.
Operating margin = Operating profit ÷ Net sales or revenues

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