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 Purple Panda Products Inc. and make comments on its second-year performance as compared to its first-year performance.

The following shows Purple Pandas income statement for the last two years. The company had assets of $8,225 million in the first year and $13,157.20 million in the second year. Common equity was equal to $4,375 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.

Purple Panda Products Inc. Income Statement For the Year Ending on December 31 (Millions of dollars)

	Year 2	Year 1
Net Sales	4,445	3,500
Operating costs except for depreciation and amortization	1,855	1,723
Depreciation and amortization	222	140
Total Operating Costs	2,077	1,863
Operating Income (or EBIT)	2,368	1,637
Less: Interest	237	213
Earnings before taxes (EBT)	2,131	1,424
Less: Taxes (40%)	852	570
Net Income	1,279	854

Calculate the profitability ratios of Purple Panda Products Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio	Value
	Year 2	Year 1
Operating profit margin		46.77%
Net profit margin	28.77%
Return on total assets		10.38%
Return on common equity		19.52%
Basic earning power	18.00%

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 profit 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 the return on assets ratio implies an increase in the assets a firm owns.

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