$5.$ Profitability ratios

Profitability ratios help in the analysis of the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm.

Your boss has asked you to calculate the profitability ratios of Sixty$-$Second Avenue Inc. and make comments on its second$-$year performance as compared with its first$-$year performance.

The following shows Sixty$-$Second Avenue Inc.$$s income statement for the last two years. The company had assets of $$3,525$ million in the first year and $$5,639$ million in the second year. Common equity was equal to $$1,875$ million in the first year, and the company distributed $100\%$ of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year.

Sixty$-$Second Avenue Inc. Income Statement For the Year Ending on December $31($Millions of dollars$)$

Year $2$

Year $1$

Net Sales $1,9051,500$

Operating costs except depreciation and amortization $1,6101,495$

Depreciation and amortization $9560$

Total Operating Costs $1,7051,555$

Operating Income $($or EBIT$)200-55$

Less: Interest $20-7$

Earnings before taxes $($EBT$)180-48$

Less: Taxes $(25\%)45-12$

Net Income $135-36$

Calculate the profitability ratios of Sixty$-$Second Avenue Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio

Value

Year $2$ Year $1$

Operating margin $-3\mathrm{.}67\%$

Profit margin $7\mathrm{.}09\%$

Return on total assets $-1\mathrm{.}02\%$

Return on common equity $-1\mathrm{.}92\%$

Basic earning power $3\mathrm{.}55\%$

Decision makers and analysts look deeply into profitability ratios to identify trends in a company$$s profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.

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

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

An increase in a company$$s earnings means that the profit margin is increasing.

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