What Are the Different Ways to Measure Profitability?

Profitability evaluation is an evaluation of the level of profitability of project investment, and is one of the main contents of financial evaluation.

Evaluation of profitability

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The profitability evaluation includes the profitability evaluation before the income tax of all the investment of the project, the profitability evaluation after the self-funded income tax and the static profitability evaluation of the project investment.

I. Profitability evaluation index based on accrual basis

Profitability evaluation is mainly carried out through analysis and comparison of a series of profitability indicators of enterprises. The financial indicators that reflect the level of corporate profit are mainly the following.

(I) Return on total assets

The return on total assets is the ratio between the total profit of the enterprise and the average total assets in a certain period. Its calculation formula is:

In the above formula, the average total assets = (total assets at the beginning of the period + total assets at the end of the period) ÷ 2, total assets at the beginning and end of the period are taken from the balance sheet; total profits are taken from the income statement. In a market economy where competition between industries is fierce, the higher the asset profitability of an enterprise, the better the total asset utilization effect; otherwise, the worse.

(II) Net asset interest rate

Net asset interest rate is the ratio between a company's net profit and average total assets over a period of time. Its calculation formula is:

In the above formula, the average total assets = (total assets at the beginning of the period + total assets at the end of the period) ÷ 2, total assets at the beginning and end of the period are taken from the balance sheet; net profit is taken from the net profit items in the income statement. The net asset interest rate reflects the ability of a company's average total assets to generate net profit for a certain period of time, and indicates the comprehensive efficiency of the company's asset utilization. The higher the ratio, the higher the efficiency of asset utilization, and the stronger the ability of the enterprise to utilize economic resources.

(III) Return on net assets

The return on net assets is also called the return on equity. It is the ratio of a company's net profit to its average net assets over a period of time. Its calculation formula is:

In the above formula, the average net assets = (beginning net assets + ending net assets) ÷ 2 and both the opening and closing net assets are taken from the total owner's equity in the balance sheet. The return on net assets reflects the return on investment of the owner's equity, which is a comprehensive evaluation index.

(IV) Profit margin on sales

The essence of the sales profit rate reflects how much profit the company realizes in the value of the goods. There are three financial indicators that reflect the level of profitability of sales from different perspectives.

1. Gross sales margin.

Gross sales margin is the ratio of gross profit to net sales revenue. Its calculation formula is:

Sales gross profit is the balance of net sales income after deducting manufacturing costs. It is an important source of funds for companies to compensate for expenses during the period. It is also an important source of profits for companies. Whether to realize profit depends on the actual situation of its operating gross profit. Therefore, the gross profit margin of sales reflects the profit level of the enterprise in realizing the value of the goods. The larger the gross profit margin of sales, the smaller the proportion of sales manufacturing costs in the net sales revenue, the larger the gross profit, and the higher the profitability of realized value.

2. Sales profit and tax rate.

The sales profit tax rate is the ratio of the total profit and tax of the enterprise to the net sales income. Its calculation formula is:

In the above formula, the total profit and tax is a sales tax + the total profit. The sales tax and total profit are all taken from the product sales tax and the additional and total profit items listed in the income statement. The total profit and tax is the total net income of the enterprise, and it is the net added value brought by the operation of enterprise assets. The sales profit tax rate reflects the ratio of the company's net income to sales income. Therefore, this indicator can evaluate the effectiveness of enterprise asset use from the perspective of the whole society. The larger the sales tax rate, the higher the level of net income, and the better the social benefits of using corporate assets.

3 Sales margin.

Also called the main business profit margin, refers to the ratio of the company's net profit to net sales income. The calculation formula is as follows:

In the above formula, net profit refers to the after-tax profit of the enterprise. Net sales margin reflects the level of net profit realized by the enterprise. The higher the net sales margin, the stronger the company's ability to obtain net profit.

(E) Cost Expense Margin

The cost expense margin is the ratio of the total profit of the enterprise to the total cost expense. Its calculation formula is:

In the above formula, the total cost cost = total product manufacturing cost + total period cost. Costs are all expenses incurred in the production and operation of an enterprise. Cost expense profit rate is an important financial indicator that reflects the level of consumption profit of an enterprise. The higher the cost expense profit rate is, the higher the profit level of production and operation cost of the enterprise, the better the efficiency of asset use, and the stronger the company's profitability.

2. Evaluation of Profitability Based on Realization of Payment

The cash flow financial ratios that measure the profitability are mainly as follows.

(1) Sale-to-cash ratio or profit realization ratio

Sales-to-cash ratio refers to the ratio of cash sales to sales revenue for a certain period of time.

Its calculation formula is:

In the above formula, the cash receipts from sales are derived from the cash flow statement, and the sales income is the net product sales realized during the period, derived from the income statement. This indicator aims to measure the degree of sales revenue in the current year to evaluate the quality of sales work. The higher the ratio, the less the company's backlog of funds on the accounts receivable, and the lower the company's operating costs. . Profit realization ratio refers to the ratio of net cash flow from operating activities to operating profits of a company over a period of time. Its calculation formula is:

In the above formula, operating profit comes from the income statement. This indicator shows the degree of difference between the net cash flow of operating activities and operating profit, and it can effectively prevent the company's book profit from operating manually.

(II) Capital cash flow ratio

The cash flow ratio of capital refers to the ratio of the net cash flow of the company's operating activities to the total capital in a certain period. Its calculation formula is:

In the above formula, total capital = (paid capital at the beginning of the period + paid-in capital at the end of the period) ÷ 2. This indicator measures the ability of an enterprise to use its invested capital to operate and create cash, and reflects the company's ability to return to its owners. The higher the ratio, the stronger the ability of the owner to invest in capital.

(3) Cash return on total assets

Cash return on total assets refers to the ratio of a company's operating net cash flow to total assets over a period of time. Its calculation formula is:

In the above formula, total assets = (total assets at the beginning of the period + total assets at the end of the period) ÷ 2. This indicator aims to measure the ability of an enterprise to use all economic resources to operate and create cash. It is a comprehensive indicator that reflects the comprehensive effect of the use of corporate assets. The higher this ratio, the more efficient the use of corporate assets.

1 China Civil Aviation Administration Planning Development Science and Technology Bureau China International Engineering Consulting Corporation Transportation Project. Civil Airport Construction Project Evaluation Method. China Economic Press, July 2000, 1st edition.

2 Sun Maozhu, Fan Ye. Finance Management. Renmin University of China Press, 2008.09. ^[1]