Subject: Principles of Accounting
Profitability ratio is a measure of profitability which helps to measure the performance of company. They are used to assess a company's ability to earn profit or income compared to its expenses or other relevant cost that are incurred during a certain period of time.
where,
Illustration:
The followings are the information of ‘Caret Co’:
Opening stock Rs. 60,000 | Closing stock Rs. 40,000 |
Purchase Rs. 3,20,000 | Purchase return Rs. 5,000 |
Sales Rs. 6,00,000 | Manufacturing expenses Rs. 55,000 |
Sales return Rs. 25,000 |
Required: Gross profit ratio
Solution:
Here,
Net sales
= Sales – sales return
= 6,00,000 – 25,000
= Rs. 5,75,000
Cost of goods sold
= Opening stock + Net Purchase + Direct expenses – Closing stock
= 60,000 + (3,20,000 – 5,000) + 55,000 – 40,000
= Rs. 3,90,000
Gross profit:
= Net sales – Cost of goods sold
= 5,75,000 – 3,90,000
= Rs. 1,85,000
Hence,
Gross profit ratio
=\(\frac {Gross profit}{Net sales}\) x 100%
=\(\frac {1,85,000}{5,75,000}\) x 100%
= 3.22%
where,
Illustration:
Calculate Gross profit ratio and Net profit ratio
Solution:
where,
Further, Return on Assets can be calculated in other ways too. Such as:
Illustration:
Balance Sheet of 'ET Co.' as on 31^{st} Chaitra, 2070 is as follows:
Required: Return on Assets
Solution:
Here,
Net profit after tax = Profit for the year = Rs. 7,00,000
Interest
= 10% on debentures
= 10% on Rs. 12,00,000
= Rs. 1,20,000
Total assets
= Net fixed assets + long term investment + current assets
= Rs. (18,00,000 + 10,00,000 + 4,00,000)
= Rs. 32,00,000
Finally,
Return on Assets (ROA)
= \(\frac {Net profit after tax}{Total assets}\) x 100%
=\(\frac {7,00,000 + 1,20,000}{32,00,000}\) x 100%
= 25.625%
where,
Illustration:
Calculate Shareholders’ fund from the followings:
Net profit before interest & tax Rs. 2,00,000
Preliminary expenses Rs. 7,000
Reserve & Surplus Rs. 40,000
Equity share capital Rs. 1,80,000
12% preference share capital Rs. 3,00,000
8% debentures Rs. 1,20,000
Tax on profit 45%
Solution:
Here,
Net profit before interest & tax Less: Interest (8% on 1,20,000) Net profit before tax Less: tax (45% of 1,90,400) | Rs. 2,00,000 9600 |
1,90,400 85,680 | |
1,04,720 |
Then,
Shareholders’ fund
= 12% preference share + Equity share + Reserve & Surplus – Preliminary expenses
= 3,00,000 + 1,80,000 + 40,000 – 7,000
= Rs. 5,13,000
Finally,
Return on Shareholders’ Equity
= \(\frac {Net profit after tax + interest}{Shareholders' fund}\) x 100%
= \(\frac {1,04,720}{5,13,000}\) x 100%
= 20.41%
where,
Illustration:
Calculate Return on shareholders’ equity and Return on common shareholders’ equity from the Balance Sheet given below:
Liabilities | Amount (Rs.) | Assets | Amount (Rs.) |
Equity share capital Reserve & Surplus 7% Debentures Current liabilities 10% preference share capital Profit & loss a/c | 3,00,000 1,40,000 80,000 1,50,000 70,000 1,20,000 | Fixed assets (net) Other quick assets Preliminary expenses Term investment Closing stock | 5,00,000 2,70,000 15,000 50,000 25,000 |
8,60,000 | 8,60,000 |
Additional information:
Solution:
Here,
Fixed assets turnover
= Sales / Fixed assets
or, 2 = Sales / 5,00,000
or, Sales = Rs. 10,00,000
Common shareholders’ equity
= Equity share + Reserve & surplus + P&L – Preliminary expenses
= Rs. (3,00,000 + 1,40,000 + 1,20,000 – 15,000)
= Rs. 5,45,000
Shareholders’ equity
= Common shareholders’ equity + Preference share
= Rs. (5,45,000 + 70,000)
= Rs. 6,15,000
Net profit after interest & tax
= (Net profit before tax & interest – interest on debentures) (1-t)
= (10% on 10,00,000 – 7% on 80,000)(1 – 0.50)
= Rs. (1,00,000 – 5,600) â‚“ 0.5
= Rs. 47,200
Hence,
Return on Shareholders’ Equity
=\(\frac {Net profit after tax + interest}{Shareholders' fund}\) x 100%
= \(\frac {47,200}{6,15,000}\) x 100%
= 7.67%
Again,
ROE
=\(\frac {Net profit after tax - preference dividend}{Common shareholders' equity}\) x 100%
= \(\frac {47,200 - 7,000}{5,45,000}\) x 100%
= 7.38%
where,
Illustration:
Calculate Return on Capital Employed
Liabilities | Amount (Rs.) | Assets | Amount (Rs.) |
Equity share capital Outstanding expenses 11% Debentures General reserve Creditors P&L a/c | 6,00,000 40,000 3,60,000 1,10,000 2,15,000 1,40,000 | Fixed assets Bank balance Preliminary expenses Investment Debtors Inventories | 7,70,000 50,000 25,000 1,00,000 3,20,000 2,00,000 |
14,65,000 | 14,65,000 |
Sales is Rs. 10,00,000
Tax rate is 32%
Net profit before tax is Rs. 3,00,000
Solution:
Here,
Net profit after interest & tax
= (Net profit before tax & interest – interest on debentures) (1-t)
= Rs. (3,00,000 – 39,600)(1 – 0.32)
= Rs. 1,77,072
Capital employed
= Equity share + Reserve + P&L a/c + Debentures – Preliminary expenses
= Rs. (6,00,000 + 1,10,000 + 1,40,000 + 3,60,000 – 25,000)
= Rs. 11,85,000
Therefore,
Return on capital employed:
=\(\frac {Net profit after tax+interest}{Capital employed}\) x 100%
= \(\frac {1,77,072}{11,85,000}\) x 100%
= 14.94%
References:
Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu
Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu
Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu
© 2019-20 Kullabs. All Rights Reserved.