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 Randall and Arts Inc. and make comments on its second-year performance as compared with its first-year performance.

The following shows Randall and Arts Inc.s income statement for the last two years. The company had assets of $4,700 million in the first year and $7,518 million in the second year. Common equity was equal to $2,500 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.

Randall and Arts Inc. Income Statement For the Year Ending on December 31 (Millions of dollars)

	Year 2	Year 1
Net Sales	2,540	2,000
Operating costs except depreciation and amortization	1,855	1,723
Depreciation and amortization	127	80
Total Operating Costs	1,982	1,803
Operating Income (or EBIT)	558	197
Less: Interest	75	21
Earnings before taxes (EBT)	483	176
Less: Taxes (25%)	121	44
Net Income	362	132

Calculate the profitability ratios of Randall and Arts Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio	Value
	Year 2	Year 1
Operating margin		9.85%
Profit margin	14.25%
Return on total assets		2.81%
Return on common equity		5.28%
Basic earning power	7.42%

Decision makers and analysts look deeply into profitability ratios to identify trends in a companys 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.

If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales.

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 profit margin is increasing.

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