Profitability Ratio- How to Calculate and Interpret?


Profitability ratios tell us how well a firm manages its assets, typically in terms of the proportion of revenues that are left over after expenses. They therefore measure the overall profitability of the company and enable a comparison between two years to determine whether the company is doing better or worse than the previous year as explained by our UK accounting homework help online experts. In this analysis this report will assess profitability by examining the following ratios:
  • The Gross Profit Margin
·         The Net Profit Margin
·         The Return on Capital Employed
An examination of the Gross Profit margin shows a considerable year on year improvement. “A record gross margin of 61.8% was achieved for the full year, an Improvement of 376 basis points compared to the prior year.” (Specialty Fashion Group Limited; Directors’ Report; 2013 Annual Report; pg. 31.)  The Directors’ Report attributed the improved Gross margin position to reduced product costs and reduced freight costs which resulted from investments made in transforming the supply chain. The point to note is that the company has improved its position and was able to recover from a negative net income position in the previous year. This success was partly due to increased online trading which grew by 50% in the current year. The evaluation of the Net Profit margin shows it was three percent(3%) for 2013 up from negative one percent ( – 1% ) in 2012. The Net Profit Margin is important because it represents the bottom line. If the ratio is too low a business needs to look at its operating expenses. Also attention has to be paid to its cost of sales since the size of the Gross Profit impacts upon the Net Profit as per our best UK accounting homework helpers. For Specialty Fashion Group Limited it indicates that for every $100 of sales $3.00 was left for profit after deducting cost of sales and operating expenses. This has increased for Specialty Fashion group limited and can have resulted from increased selling prices and tighter control of operating costs.

The Return on capital employed also showed a positive increase in 2013 up from a negative figure in the previous year. This ratio was 22% in 2013 up from a negative one percent (-1%) inn 2012. “The ROCE is the primary ratio and is considered the most important of the ratios and the one that forms the starting point in ratio analysis.” (Randall H. 3rd ed; 2001; pg.463) This can serve as a benchmark for Specialty Fashions limited when borrowing or assessing a new project. It is already showing signs of improvement which is a positive sign. If it is too low it could easily turn into a loss if the company’s fortunes were reversed.

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