Finance
Basics: Business
Profitability (B)
by
Laurus Nobilis
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What
are measures of business profitability?
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Posted
Apr 2009 |
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<<<
Previously on Finance Basics: Accounting
for Inventory
BUSINESS
PROFITABILITY
In
this final section we will take a step back from the
business at the point it has reached now and spend some
time reflecting on the results achieved and the
questions raised for the future.
Note: The exercise should be done before looking at the
concepts for this section
DAY
TEN
The
last day of the test run dawns... JS decides to close
the business for now and wrap up everything neatly, by:
•
collecting all outstanding debts
• only
selling for cash
At
the end of the day he also decides to pay cousin half
the money he owes for the equipment, or $750.
JS
makes sure to let all his, by now regular, customers
know that the best run lemonade stand in town will be
back soon...
PROFIT
RATIOS
Performance
can be measured through financial ratios. Two of those
frequently used in business are:
Return
On Equity
(ROE): the amount of return made from the
shareholder's perspective
Accumulated profit/loss
(over a particular time period)
ROE
= -----------------------------------------------------------------------
Shareholders'
investment
A
ratio is useful for comparing performance over time or
between companies.
Return
On Sales (ROS): measures profit made on operations,
not taking into account the means of financing.
Earnings bef. interest + taxes (over a particular time
period)
ROS = -----------------------------------------------------------------------
Total
sales revenue
VALUE
CREATION
A
profitable business generates wealth for those who have
contributed financing to the business.
•
interest payments to lenders who have contributed
loan capital
•
returns to shareholders who have contributed
equity capital, in the form of
- dividends
paid from profits, or
-
an increase in value of their share in the company.
The
economic value created by the company benefits many
other stakeholders:
•
customers
•
suppliers
•
employees
•
government
FUTURE RETURNS
Looking
at the future, there are many questions about the
ability of the company to realise profits.
•
Is the expected return comparable to other
opportunities available?
•
How does the expected return compare with the
risks involved ?
•
If the assets were sold, would the amount
received cover the liabilities of the company ?
•
Will the company be able to continue its
profitable performance in the face of uncertainties and
risks?
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