There are various profitability ratios that allow investors to compare a company's profit with its sales, its assets or its capital. Financial analysts usually include them in their reports on companies.

gross profit (sales - cost of goods sold) This is the gross profit margin. It is the money a

_{sa}j_{es} company has left after it pays for the cost of the goods

or services it has sold. A company with a higher gross profit margin than competitors in its industry is more efficient, and should be able to make a profit in the future.

net profit This is return on assets. It measures how efficiently the firm's assets are being used

total assets ^{to} §^{enerate} P^{rofits}'

net profit This is return on equity (ROE). It shows how big a company's profit is

shareholders^{5} equity (after interest and tax) compared with the shareholders' equity or funds.

This is gearing or leverage, often expressed as a percentage. It shows how far a company is funded by loans rather than its own capital. A highly geared or highly leveraged company is one that has a lot of debt compared to equity.

Leverage

debt

shareholders' equity

EBIT (see Unit 14) interest charges

This is interest cover or times interest earned. It compares a businesses annual interest payments with its earnings before interest and tax, and shows how easily the company can pay long-term debt costs. A low interest cover (e.g. below 1.0) shows that a business is having difficulties generating the cash necessary for its interest payments.

3.2 1.0

15.7 .2

14.5 2.5

■

:

Citigroup Inc Key Ratios, 2005

Citigroup

BrE: gearing; AmE: leverage

Banking Industry Average

S&P 500 Average

Growth Rates %

Sales

1 1.5

29.4

10.7

EPS

3.2

21.2

1 1.2

Price Ratio

P/E Ratio

13.9

14.5

20.6

Profit Margins

Pre-Tax Margin

21.8

23.7

47.3

Net Profit Margin

15.5

16.3

7.6

Financial Condition

Debt/Equity Ratio

1.9

1.32

I.I

Interest Cover

2.0

2.1

3.4

Investment Returns %

Return On Equity Return On Assets

1 6.1 Match the two parts of the sentences. Look at A and B opposite to help you.

1 After borrowing millions to finance the takeover of a rival firm, the company's

2 Although sales fell 5%, the company's

3 Like profit growth, return on equity is a measure of

4 With just 24% gearing, the company can afford

a gross profit margin rose 9% from a year ago, so senior management isn't worried, b how good a company is at making money, c interest cover is the lowest it has ever been.

d to acquire its rival, which would help to increase its steady growth. 16.2 Read the text and answer the questions below. You may need to look at Units 11-14.

Predicting insolvency: the Altman Z-Score

The Z-Score was created by Edward Altman in the 1960s. It combines a set of 5 financial ratios and a weighting system to predict a company's probability of failure using 8 variables from its financial statements.

I

I

The ratios are multiplied by their weights, and the results are added together. The 5 financial ratios and their weight factors are:

A

EBIT / Total Assets

x 3.3

B

Net Sales / Total Assets

x 0.999

C

Market Value of Equity / Total Liabilities

x 0.6

D

Working Capital / Total Assets

x 1.2

E

Retained Earnings / Total Assets

x 1.4

Therefore the Z-Score = A x 3.3 + B x 0.999 + C x 0.6 + D x 1.2 + E x 1.4

Interpreting the Z-Score

> 3.0 - based on these financial figures, the company is safe

2.7- 2.99 - insolvency is possible

£

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1.8- 2.7 - there is a good chance of the company going bankrupt within 2 years < 1.80 - there is a very high probability of the company going bankrupt

Which ratio in the Z-Score takes into account:

1 money used for everyday expenses?

2 undistributed profits belonging to the shareholders?

3 income or earnings before interest and tax are deducted?

4 the current share price?

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Ov^r + O lApU

Look at the financial statements of a company you are interested in and calculate the company's Z-Score. Is it in good financial health?

5 the amount of money received from selling goods or services?