Q11RQ - Horngren'S Financial And Managerial Accounting

Question

Briefly describe the ratios that can be used to evaluate a company’s profitability.

 

Step-by-Step Solution

Answer

A company can use the profitability ratiosto evaluate its profitability.

Step 1: Meaning of Profitability Ratio

The profitability ratios are the ratios that determine a company's power to produce revenue concerning its outlays and other expenses incurred in income production during a specific timeframe. This ratio can determine the company's ultimate performance.

 

Step 2: Explanations of various profitability ratios

• Return on Equity

 

This ratio evaluates the profitability of the equity fund that the corporation has invested in the business. The higher the ratio, the better it is. 

 

$Return on equity=\frac{\mathbf{ProfitafterTax}}{\mathbf{Networth}}$

• Earnings per Share

 

This ratio calculates the amount each shareholder can earn on the company's net income according to the number of shares they have. A higher proportion indicates a better company.

 

$Earning per share=\frac{\mathbf{NetProfit}}{\mathbf{Totalno}\mathbf{.}\mathbf{ofsharesoutstanding}}$

 

• Return on Capital Employed

 

This ratio calculates the percentage of the money a business earns by how efficiently using the capital invested in the company. A higher ratio is considered better.

 

$Return on capital employed=\frac{\mathbf{NetOperatingProfit}}{Capital employed}\mathbf{\times }\mathbf{100}$

 

• Return on Assets

 

This ratio calculates the rate of return a company earns by using the company's assets efficiently. A high ratio indicates that a company is doing better.

 

$Return on Assets=\frac{\mathbf{NetProfit}}{Total Assets}$

 

• Gross Profit

 

This ratio calculates the percentage of profit a company earns on its selling price. A high ratio helps the corporation since it indicates a higher profit margin.

 $Gross profit ratio=\frac{\mathbf{GrossProfit}}{\mathbf{Sales}}\mathbf{\times }\mathbf{100}$