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 Stay Swift Corp. and make comments on its second-year performance as compared with its first-year performance.

The following shows Stay Swift Corp.s income statement for the last two years. The company had assets of $11,750 million in the first year and $18,796 million in the second year. Common equity was equal to $6,250 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.

Stay Swift Corp. Income Statement For the Year Ending on December 31 (Millions of dollars)

	Year 2	Year 1
Net Sales	6,350	5,000
Operating costs except depreciation and amortization	1,365	1,268
Depreciation and amortization	318	200
Total Operating Costs	1,683	1,468
Operating Income (or EBIT)	4,667	3,532
Less: Interest	467	283
Earnings before taxes (EBT)	4,200	3,249
Less: Taxes (25%)	1,050	812
Net Income	3,150	2,437

Calculate the profitability ratios of Stay Swift Corp. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio	Value
	Year 2	Year 1
Operating margin		70.64%
Profit margin	49.61%
Return on total assets		20.74%
Return on common equity		38.99%
Basic earning power	24.83%

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 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, return on common equity will increase.