Unit III

Profitability Ratios

Dr.K.Nithya Kala CMA Unit III 1

Profitability Ratios are calculated to measure overall efficiency of
the business.

Profitability ratios are calculated either in relation to sales or in

relation to investment.

The general profitability Ratios are:

i) Gross Profit Ratio

ii) Operating Ratio
iii)Operating Profit Ratio
iv)Expenses Ratio
v) Net Profit Ratio
vi)Cash Profit Ratio
i)Gross Profit Ratio = (Gross Profit / Net Sales)*100
= (Revenue from Operations (Sales) – Cost of Revenue from Operations (Goods Sold)/ Sales)*100

Cost of Revenue from Operations = Purchases + Return Outwards + Direct Expenses +

Opening Inventories – Closing Inventories

Higher the Gross Profit Ratio better the results.

ii) Operating Ratio = (Operating Cost / Net Revenue from Operations (Sales))*100
= (Cost of Revenue (Goods Sold) + Operating Expenses / Net Revenue from Operations
(Sales))*100

iii) Operating Profit = (Operating Profit / Revenue from Operations (Sales)) *100
Net Revenue from Operations (Sales) – Operating Cost
= Net Revenue (Sales) – (Cost of goods sold+ Administrative & office Expenses+ Selling & Distributive Expenses
Operating Profit = Net Profit + Non-Operating Expenses – Non-Operating Income
Operating Profit = 100 – Operating Ratio
iv) Particular Expenses Ratio = (Particular Expenses / Net Sales (Revenue from Operations))*100

i) Cost of Goods Sold Ratio or

Cost of Revenue Ratio =(Cost of Goods Sold or Cost of Revenue from Operations / Sales) *100
ii) Administrative & Office Expenses Ratio = (Administrative & Office Expenses / Sales ) *100
iii) Selling & Distribution Expenses Ratio = (Selling & Distribution Expenses/ Sales ) *100
iv) Non-Operating Expenses Ratio = (Non-Operating Expenses / Sales )*100
v) Net Profit Ratio = (Net Profit After Tax / Net Revenue from Operations (Sales)) *100

v) Net Profit Ratio =(Net Operating Profit / Net Revenue from Operations (Sales)) *100

vi) Cash Profit Ratio = (Cash Profit / Net Sales)*100

Cash Profit = Net Profit + Depreciation
1. From the following information you are required to calculate
a) Gross Profit Ratio
b) Net Profit Ratio
c) Operating Ratio
d) Operating Profit Ratio
e) Administrative Expenses Ratio
Dr Cr
To opening stock 1,00,000 By Sales 5,60,000
To purchases 3,50,000 By Closing Stock 1,00,000
To wages 9,000
To Gross Profit c/d 2,01,000
6,60,000 6,60,000
To Administrative expenses 20,000 By gross profit b/d 2,01,000
To selling & distribution 89,000 By interest on investment (outside 10,000
business)
To non-operating expenses 30,000 By profit on sale of investments 8,000
To Net Profit 80,000
2,19,000 2,19,000
a) Gross Profit Ratio = (Gross Profit / Net Sales)*100
= (2,01,000 / 5,60,000)*100
= 35.9 %
b) Net Profit Ratio =(Net Profit (after tax)/ Net Sales)*100
=(80,000 / 5,60,000)*100
= 14.3 %
Or Net Profit = (Net Operating Profit / Net Sales)*100
= ((80,000 +30,000) – (10,000 +8000) / 5,60,000)*100
= (92000 / 5,60,000)*100
= 16.4%
c) Operating Ratio = (Cost of Goods Sold + Operating Expenses) / Net Sales
Cost of Goods Sold = Op. St + Purchases + Wages – Cl. St
= 1,00,000 +3,50,000 + 9,000 – 1,00,000
= Rs.3,59,000
Operating Expenses = Administrative + Selling & Distribution Expenses
= 20,000 + 89,000
= Rs.1,09,000
d)Operating Ratio = (Rs.3,59,000 + Rs.1,09,000 / Rs.5,60,000) *100
= (4,68,000 / 5,60,000)*100
= 83.6%
Operating Profit Ratio = 100 – Operating Ratio = 100 -83.6% = 16.4%

e) Administrative Expense Ratio = (Administrative Expenses / Net Sales ) *100

= (20,000 / 5,60,000)*100 = 3.6%
Try it Yourself
The following is the revenue statement of a Ltd Company for the year ended 31 st March 2011

Particulars Rs.
Sales / Revenue from Operations 6,00,000
Less: Cost of Revenue 4,00,000
Gross Profit 2,00,000
Less : Operating expenses 1,20,000
Operating Profit 80,000
Add: Non-Operating Income 12,000
92,000
Less: Non-operating expenses 4,000
Net Profit 88,000

Calculate:
a) Gross Profit Ratio
b) Operating Ratio
c) Operating Profit Ratio
d) Net Profit Ratio
 Unit III

Overall Profitability Ratios

Dr.K.Nithya Kala CMA Unit III 8

Overall Profitability Ratios
1. Return on Shareholder’s
Investment or Net Worth
2. Return on Equity Capital
3. Earnings per Share
4. Return on Capital Employed
(ROI)
Net Profit (after interest & tax) / Shareholder’s Fund
Net Profit After Tax – Preference Dividend / Equity Share Capital (Paid -Up)
Net Profit After Tax – Preference Dividend / No. of Equity Shares
A) Assets Approach
i)Gross Capital Employed = Non-Current Assets + Current Assets
ii)Net Capital Employed = Total Assets – Current Liabilities
iii) Proprietor's Net Capital Employed = Non-Current Assets+ Current Assets-Outside
liabilities
B) Liabilities Approach
Total of all liabilities + Increase in value of assets on replacement cost – (Accumulated loss,
Fictitious Assets, Intangible Assets, idle or absolute assets, investment outside the
business)
Average Capital Employed
a) Average Capital Employed = (Opening Capital Employed + Closing Capital Employed)/ 2
b) Average Capital Employed = Closing Capital Employed – ½ of the profit earned during
the year
c) Average Capital Employed = Opening Capital Employed +1/2 of profit earned during
the year
Return on Gross Capital Employed = (Adjusted Net Profits / Gross Capital Employed)*100
Return on Net Capital Employed = (Adjusted Net Profits / Net Capital Employed)*100 or
ROI = Net Profit Ratio * Capital Turnover Ratio
5. Return on Assets Net Profit After Tax / Average Total Assets
Or
Net Profit After Tax / Average Tangible Assets
Net Profit After Tax / Average Fixed Assets

Market Test or Valuation Ratio

6. Capital Turnover Ratio Total Sales / Shareholder’s Equity
7. A) Dividend Yield Ratio Dividend per Equity Share / Market Value per Share
B) Dividend per Share Dividend Paid to Shareholders/ Number of Shares

8. Dividend Pay-out Ratio Dividend per Equity Share / Earnings per Share
9. Price Earning (Earning Yield) Ratio or P/E Ratio Market Price per Equity Share / Earnings per Share

10. Earnings Yield Ratio (Earnings per share / Market price per share)*100
11. Market Value to Book Value Ratio Market Value per Share / Book Value per Share
Book value per share = (Equity. Share Capital + Reserves & Surplus
-Accumulated Losses) / Total Number of Equity Shares

12. Market Price to Cash Flow Ratio Market Price per Share / Cash Flow per Share
Cash Flow per Share = Profit + Depreciation / Total no. Equity Shares
1. Calculate return on shareholders’ investment

Issued and Subscribed Capital Rs. Rs.

2000 equity shares of Rs.100 each 2,00,000
1000 8% preference shares of Rs.100 each 1,00,000
3,00,000
Reserves & Surplus:
Revenue Reserve 30,000
Capital Reserve 50,000
Reserves for Contingencies 20,000 1,00,000
Net Profit before interest & tax 1,50,000
Interest Charges 30,000
Tax Rate 50%
Solution:

Shareholders’ Investments (Funds) = Eq.Sh.Cap + Pref. Sh. Cap + Reserves & Surplus
= 2,00,000 + 1,00,000 + 1,00,000 = Rs.4,00,000

Net Profit before Interest & Tax Rs. 1,50,000

Less: Interest Rs. 30,000
Rs. 1,20,000
Less : Income Tax @ 50% Rs. 60,000
Net Profit after interest & tax Rs. 60,000

Return on Shareholders’ Investment = Net profit after Interest & Tax / Shareholders Investment
= (60,000 / 4,00,000)*100
= 15%
2. From the following Information Calculate Return on Equity Capital
Particulars Rs.
10,000 equity shares of Rs. 10 each & 80,000
Rs.8 paid
11% 5000 preference share of Rs.20 each Rs.1,00,000
Profit before tax Rs.80,000
Rate of Tax 50%
Calculate : Return on Equity Capital

Solution:
Return on Equity Capital = (Net Profit After Tax – Preference Dividend / Equity Share Capital ) *100
Particulars Rs.
Profits 80,000
Less: Tax @ 50% 40,000
Profits after Tax 40,000
Less: Preference Dividend 11,000
Rs.29,000

Return on Capital Employed = (Rs.29000 / Rs.80,000)*100 = 36.25%

 3. The following is the balance sheet of B ltd for the year ending 31 st March 2018
Particulars Rs. Particulars Rs.

I. Equity & Liabilities II. Assets

Shareholders Fund Non Current Assets:
50,000 Equity Shares of Rs.10 each fully paid 5,00,000 Tangible Assets:
20,000 Preference Shares of Rs.20 each fully paid 4,00,000 Freehold Property 1,00,000
Reserves & Surplus Plant & Machinery 2,00,000
Profit & Loss Account ( Including Rs.4,00,000 1,00,000 Land & Building 4,00,000
current year Profits)
Less: Preliminary Expenses (25000) Furniture 45,000
Non-Current Liabilities Intangible Assets:
5% Debentures 1,00,000 Good Will 50,000
Current Liabilities: Current Assets:
Sundry Creditors 40,000 Stock 1,75,000
Bills Payable 60,000 Debentures 55,000
Cash at Bank 1,50,000
11,75,000 11,75,000
 The value of Land & Building will be Rs.45,000 and Plant & Machinery Rs.1,80,000. Goodwill has no value.
Calculate:
1) Gross Capital Employed
2) Net Capital Employed
3) Average Capital Employed

Solution:
Capital Employed Rs.
Freehold Property 1,00,000
Plant & Machinery 1,80,000
Land & Building 4,50,000
Furniture 45,000
Stock 1,75,000
Debtors 55,000
Cash at Bank 1,50,000
i)Gross Capital Employed 11,55,000
ii) Net Capital Employed =Tangible Assets – Current Liabilities
=11,55,000 - (40000+60,000)
=10,55,000
iii) Average Capital Employed = Capital Employed – One Half of Current Years Profits

Average Capital Employed:

a) Gross = Gross Capital Employed – ½ of Current Year’s Profits
= 11,55,000 -1/2 (40,000)
= Rs.11,35,000

b) Net = Net Capital Employed -1/2 (of Current Year Profits)

= Rs.10,55,000 -1/2 (40,000)
= Rs.10,35,000
4. From the following information calculate Return on Capital Employed (Net)
Particulars Rs
Share Capital 1,00,000
Reserves & Surplus 50,000
Non-Current Liabilities (12% Long Term Borrowings) 4,00,000
Net Fixed Assets 4,50,000
Non- Current trade investments 50,000
Current Assets 2,20,000
Current Liabilities 1,70,000

Net Profit Before Tax Rs.1,20,000

Solution:
Return on Capital Employed = (Net Profit Before Interest Tax / Capital Employed) *100
Net Profit Before Interest Tax = Net Profit Before Tax + Interest
= 120000 + 48000 (12 % of 4,00,000)
= Rs.1,68,000
Capital Employed = Share Capital + Reserves & Surplus +Non-Current Liabilities
= 100000 + 50,000+ 4,00,000 = Rs.5,50,000
Return on Capital Employed = (1,68,000 / 50,000)*100 = 30.54 %
 5. Compute the Pay out ratio and retained earnings
Particulars Amt Rs.
No of Equity Shares 3000
Dividend per Equity Share 0.40
Net Profit 10,000
Provision for tax 5000
Preference Dividend 2000

Solution:
Pay out Ratio = Dividend per Equity Share / Earnings per Share
Earnings per Share = Earnings for Equity Shareholders / No of Equity Shares
EPS = (10,000 -5000-2000 /3000)
= Re.1
Pay –out ratio = (0.40 / 100)*100
= 40%
Retained Earnings Ratio = 100 – Pay out Ratio
= 100 – 40%
= 60%
Retained Earnings Ratio =( Retained Earnings per Share / Total Earnings per Share ) *100
= ((1-0.4) /1)*100
= 60%
6. The information of Star Ltd. as follows
80,000 equity shares of Rs.10 each Rs.8,00,000
9% 30,000 Preference Shares of Rs.10 each Rs.3,00,000
Rs.11,00,000

The following information has been obtained from the books of the company
Profits after tax at 60% Rs.2,70,000
Depreciation Rs.60,000
Equity Dividend Paid 20%
Market price of Equity Shares Rs.40

You are Required to Calculate:

a) Dividend Yield on equity shares
b) Cover for the preference dividend
c) Cover for the equity dividend
d) Earnings per Share
e) The Price earnings ratio
f) Net cash flow
a) Dividend Yield on Equity Shares
b) Cover for the Preference Dividend
c) Cover for the Equity Dividend
d) Earnings per Share
e) Price Earning ratio
f) Net Cash Flow
(Dividend per Share / Market Price Per Share)*100
= 2 ( 20% of 10) / 40
= 0.5 or 5%
Profits After Tax / Preference Dividend
= 2,70,000 / (300000*9/100)
= 10 times
Profits after Tax & Preference Dividend / Equity Dividend
= 270000 – 27000 / (800000 *20/100)
= 1.52 times
Profits after tax & Preference dividend / No. of Equity Shares
= ((270000 – 27000) / 80000)
= Rs.3.04
Market Price Per Share / Earnings per share
=40/3.04
= 13.1 : 1
Total Cash Flow – Dividend
= ( Net Profit + Depreciation – Dividend)
= (270000 + 60000) – ( 27000+160000)
= 3,30,000 -187000
= 1,43,000