Cash Flow

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Profitability Ratios: How Profitable is the Company?

Net sales/Net profit after taxes

The information necessary to determine a company’s profit as a percentage of sales can be found in the company’s income statement.

1. Magnetronics’ profit as a percentage of sales for 1999 was $1,307 divided by $48,769, or 2.68%.

2. This represented a decrease from 3.6% in 1995.

3. The deterioration in profitability resulted from a decrease in cost of goods sold as a percentage of sales, and from a decrease in operating expenses as a percentage of sales. The only favorable factor was the decrease in the income tax paid.

Management and investors are often more interested in the return earned on the funds invested than in the level of profits …show more content…

Magnetronics had net fixed assets of $5,160 and sales of $48,769 in 1999. Its fixed asset turnover ratio in 1999 was 9.45 times, an improvement from 7.98 times in 1995.

5. So far, we have discussed three measure of profitability: They are (a) return of equity (b) return on invested capital and (c) net profit margin. We have also discussed four activity ratios which measure the effectiveness of the company in utilizing its assets: they are (d) total asset turnover (e) asset turnover ratio (f) inventory turnover ratio and (g) average collection period.

6. The deterioration in Magnetronics’ operating profits as a percentage of total assets between 1995 and 1999 resulted primarily from inefficient use of inventory and total assets, increase in COGS and operating expenses as a percentage of sales.

Leverage Ratios: How Soundly is the Company Financed?

The third basic type of financial ratio is the leverage ratio. The various leverage ratios measure the relationship of funds supplied by creditors and the funds supplied by the owners. The use of borrowed funds by profitable companies will improve the return on equity. However, it increases the riskiness of the business and, if used in excessive amounts, can result in financial embarrassment.

One leverage ratio, the debt ratio, measures the total

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