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 $7,050 million in the first year and $11,278 million in the second year. Common equity was equal to $3,750 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	3,810	3,000
Operating costs except depreciation and amortization	1,855	1,723
Depreciation and amortization	191	120
Total Operating Costs	2,046	1,843
Operating Income (or EBIT)	1,764	1,157
Less: Interest	238	150
Earnings before taxes (EBT)	1,526	1,007
Less: Taxes (25%)	382	252
Net Income	1,144	755

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		38.57%
Profit margin	30.03%
Return on total assets		10.71%
Return on common equity		20.13%
Basic earning power	15.64%

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.

A higher operating 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 profit margin is increasing.