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 St. McStanky Beer Co. and make comments on its second-year performance as compared with its first-year performance.

The following shows St. McStanky Beer Co.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.

St. McStanky Beer Co. 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	1,365	1,268
Depreciation and amortization	191	120
Total Operating Costs	1,556	1,388
Operating Income (or EBIT)	2,254	1,612
Less: Interest	304	169
Earnings before taxes (EBT)	1,950	1,443
Less: Taxes (40%)	780	577
Net Income	1,170	866

Calculate the profitability ratios of St. McStanky Beer Co. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio	Value
	Year 2	Year 1
Operating margin		53.73%
Profit margin	30.71%
Return on total assets		12.28%
Return on common equity		23.09%
Basic earning power	19.99%

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.

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