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Unit 4: Ratio Analysis
While discussing the measure of profitability of the firm, the profits are normally classifi ed into Notes
various categories:
1. Gross Profi t
2. Net Profi t
3. Operating Profi t Ratio
4. Return on Assets Ratio
5. Return on Capital Employed
All profitability ratios are normally expressed only in terms of (%). The return is normally
expressed only in terms of percentage which warrants the expression of this ratio to be also in
percentage.
4.5.1 Gross Profi t Ratio
The ratio elucidates the relationship in between the gross profit and sales volume.
It facilitates to study the profit earning capacity of the firm out of the manufacturing or trading
operations.
Gross Profi t Ratio = Gross Pr ofit × 100
Sales
Example: Om enterprises has earned a gross profi t of ` 6,00,000 in the fi rst quarter.
Calculate the gross profit ratio if the corresponding sales amounted to a value of ` 30,00,000.
What does it imply?
Solution:
,
Gross Profi t Ratio = Gross Pr ofit × 100 = , 600000 × 100 = 20 1
:
Sales 30 ,00 ,000
The ratio implies that the firm has earned good profits out of sales in the fi rst quarter.
!
Caution Standard norm of the ratio: Higher the ratio means that the fi rm has greater
cushion in meeting the needs of preference dividend payment against Earnings After
Taxation (EAT) and vice versa.
4.5.2 Net Profi t Ratio
The ratio expresses the relationship in between the net profit and sales volume. It facilitates to
portray the overall operating efficiency of the firm. The net profit ratio is an indicator of over all
earning capacity of the firm in terms of return out of sales volume.
Net Profi t Ratio = Net Pr ofit × 100
Sales
Example: Om enterprises has earned a net profi t of ` 3,00,000 in the first quarter. Calculate
the net profit ratio if the corresponding sales amounted to a value of ` 30,00,000. What does it
imply?
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