11. Profitability ratios

Janet has been asked to calculate the profitability ratios of Fuzzy Button Clothing Company and make comments on its second-year performance as compared to its first-year performance.

The following shows Fuzzy Buttons income statement for the last two years. The company had assets of $10,575,000 in the first year and $16,916,400 in the second year. Common equity was equal to $5,625,000 in the first year, 100% of earnings were paid out as dividends in the first year, and the firm did not issue new stock in the second year.

Fuzzy Button Clothing Company	Year
Income Statements
Years Ending December 31
	Year 2	Year 1
Net Sales	$5,715,000	$4,500,000
Operating costs less depreciation and amortization	1,120,000	1,040,000
Depreciation and amortization	285,750	180,000
Total Operating Costs	$1,405,750	$1,220,000
Operating Income	$4,309,250	$3,280,000
Interest	581,749	262,400
Earnings before taxes	$3,727,501	$3,017,600
Taxes (40%)	1,491,000	1,207,040
Net Income	$2,236,501	$1,810,560

Given the income statements, calculate the profitability ratios of Fuzzy Button Clothing Company

Profitability Ratio	Value
	Year 2	Year 1
Operating profit margin		72.89%
Net profit margin	39.13%
Return on total assets		17.12%
Return on common equity		32.19%

Which of the following statements are true about profitability ratios? Check all that apply.

A higher operating profit margin than the industry average indicates either lower operating costs, higher product pricing, or both.

If a companys operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.

An increase in a companys earnings means that the net profit margin is increasing.

If a company issues new common shares but its net income does not increase, return on common equity will increase.