Video Transcript: Profitability Ratios

Hello, welcome. We're going to be discussing profitability ratios. Profitability  ratios are a class of financial metrics that are used to assess a business's ability  to generate earnings compared to its expenses and other relevant costs  incurred during a specific period of time. For most of these ratios having a  higher value relative to a competitor's ratio, or relative to the same ratio from a  previous period, indicates that the company is doing well. So let's look at profit  margin. Profit Margin is a profitability ratio that is calculated as net income  divided by revenue, or net profits divided by sales, net income or net profit may  be determined by subtracting all of a company's expenses, including operating  costs, material costs, which includes raw materials and tax costs, from its total  revenue. Profit margins are expressed as a percentage and in effect measure  how much out of every dollar of sales a company actually keeps an earnings a  20% profit margin, then means the company has a net income of 20 cents for  each dollar of total revenue earned. So you can see we have profit margin is  equal to net income divided by net sales, or we can say profit divided by  revenue, same thing. So for this example, our net income is $30,000 so Okay,  divided by $100,000 in revenue, or sales. So we divide the 30,000 from the  100,000 we wind up with a profit margin of 30% healthy profit margin. That's a  tough goal to attain, but if we can get 30% on our profit, we're going to be in  business for a long time. Return on assets is an indicator of how profitable a  company is relative to its total cost. ROA gives a manager, investor or analyst,  an idea as to how efficient a company's management is at using its assets to  generate earnings, right? So let's take a look at this. So we want, we want to  make sure that we are efficiently and effectively using our assets to generate  revenue to grow profit margin. Right? So ROA net income divided by total  assets. So in this example, we'll see that net income is 100,000 and we're going  to divide that by total assets of 500,000 and we're going to get a 20% return on  assets. That is really good. We are becoming effective and efficient in our  operations, and it is showing that we are becoming a more profitable company  relative to our total assets. So we are using our total assets efficiently and  effectively to drive net income or profit. So a 20% return on our assets is very,  very good where the market might return you 12% 10% 20% is a healthy ROA.  Now let's look at return on equity. Return on equity is the amount of net income  returned as a percentage of shareholders equity. Return On Equity measures a  corporation's profit of profitability by revealing how much profit a company  generates with the money shareholders have invested. So we want to make  sure that we are putting to work our shareholders equity. Want to make sure that we are utilizing it and giving the shareholders the type of returns that they  deserve as putting their risk and their capital in our company. So let's check this  out. ROE equals net income divided by shareholder equity. All right, so let's look  netting net income 10,000 divided by shareholder equity at 20,000 for a 50%  return on equity. So we are doing so if these were real financial metrics and our 

company, we. Was performing at this rate. I would say, if you were the CEO, that you would be compensated, bonus wise, very, very handsomely for a year like  this, 50% return on equity is superb. We would want 20% would be excellent,  but 50% would be amazing. ROA, 20% were performing better than the market  at 10, 12, 15, even, and our profit margin at 30% is very, very healthy.