2. What is profit?
Profit is the
reward or return for
taking risks & making
investments
3. Two ways of measuring profit
• Profit in absolute terms
– The £ value of profits earned
– E.g. £50,000 profit made in the year
• Profit in relative terms
– The profit earned as a proportion of sales
achieved or investment made
– E.g. £50,000 profit from £500,000 of sales is a
profit margin of 10%
– E.g. £50,000 profit from an investment of £1
million = a 5% return on investment
6. What is ratio analysis?
Analysing relationships
Analysing relationships
between financial data
between financial data
to assess the
to assess the
performance of a
performance of a
business
business
13. What is operating profit?
Operating profit Example £’000
is what is left Sales 150
after all the Wages (50)
costs of a Energy costs (25)
business have Marketing (15)
been taken Other overheads (30)
from its sales OPERATING PROFIT 30
revenue Operating profit margin 20%
14. Operating profit margin - formula
Operating Operating profit
profit = X 100
margin Sales (or revenues)
Note: operating profit margin is
expressed as a percentage
15. What does Net Profit Margin tell us?
• How effectively a business turns its
sales into profit
• How efficiently a business is run
• Whether a business is able to “add
value” during the production process
(a high margin business must be
doing something right!)
16. The Importance of Comparison (1)
The net profit margin of a business should be
compared with other competitors in the same
market, and over time
Company A Company B Company C
Example
£’000 £’000 £’000
Sales 150 250 500
Net profit 50 25 125
Net margin 20% 10% 25%
17. The Importance of Comparison (2)
Company A Company B Company C
Example
£’000 £’000 £’000
Sales 150 250 500
Net profit 50 25 125
Net margin 20% 10% 25%
Company A makes a higher Company C makes the
net profit than Company B highest net margin of these
even though its sales are three & also the highest
lower – because it has a sales. So it makes the
higher net profit margin largest net profit too
19. Return on Capital Employed
Operating profit
ROCE (%) = x 100
Capital employed
Example
Example
Operating profit = £280,000
Operating profit = £280,000
Capital employed = £1,400,000
Capital employed = £1,400,000
ROCE = £280,000 / £1,400,000 = 20%
ROCE = £280,000 / £1,400,000 = 20%
20. Evaluating ROCE
Higher % is better
Higher % is better
ROCE Watch for trend over time
Watch for trend over time
% Watch out for low quality
Watch out for low quality
profit which boosts ROCE
profit which boosts ROCE
Leased equipment will not be
Leased equipment will not be
included in capital employed
included in capital employed