When performing a profitability ratio analysis, it is essential to take into account companies that operate in the same industry. In fact, based on the industry the profitability ratios might vary quite a lot. Even though below we have five tech companies, those operate in different contexts and competitive landscapes. In part, their business models overlap. Take Microsoft, which also serves the advertising industry with Bing. Also, a proper comparative analysis should take into account previous years. For this infographic however it is a useful exercise to appreciate how profitability metrics can change according to the industry you're taking into account.
The key metrics we take into account for the infographic are:
That is a measure of the operational efficiency of a company given by operating income over net sales. This measure is critical because it tells us the ability of a company to improve its operational efficiency over time. In fact, other metrics, like the Net Margin might be biased by factors like taxes and interest expenses, that are more tied to the company's ability to find the right tax mix and financial mix. Instead, with the operating margin, we have a quick glans at the company's operational efficiency.
It measures how good a company is in converting revenues in profits. This is a reasonable assessment of the overall business. However, when we refer to profits, it is crucial to understand the difference between cash. In fact, the income statement primary purpose is to understand the operations of an organization and not necessarily understand how much cash it has in the bank. For that, there is the cash flow statement. This metric is given by net income over net sales.
Return on Equity
Return on Capital Invested
Return on Assets
The return on assets tells you how much earnings a company generates from invested capital. Its formula is Net Income over Total Assets. It tells you how much profits are made for each additional dollar of capital invested in acquiring assets.
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