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 $9,400 million in the first year and $15,037 million in the second year. Common equity was equal to $5,000 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	5,080	4,000
Operating costs except depreciation and amortization	1,610	1,495
Depreciation and amortization	254	160
Total Operating Costs	1,864	1,655
Operating Income (or EBIT)	3,216	2,345
Less: Interest	434	305
Earnings before taxes (EBT)	2,782	2,040
Less: Taxes (25%)	696	510
Net Income	2,086	1,530

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		58.63%
Profit margin	41.06%
Return on total assets		16.28%
Return on common equity		30.60%
Basic earning power	21.39%

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.