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
sajes 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 Profits'
net profit This is return on equity (ROE). It shows how big a company's profit is
shareholders5 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.
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.
Citigroup Inc Key Ratios, 2005
BrE: gearing; AmE: leverage
Banking Industry Average
S&P 500 Average
Growth Rates %
Net Profit Margin
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.
The ratios are multiplied by their weights, and the results are added together. The 5 financial ratios and their weight factors are:
EBIT / Total Assets
Net Sales / Total Assets
Market Value of Equity / Total Liabilities
Working Capital / Total Assets
Retained Earnings / Total Assets
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
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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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?