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19 Cards in this Set

  • Front
  • Back

Define: profitability

The ability of a firm to generate earnings

In calculating profitability ratios, which items should be excluded?

1. Discontinued Operations

2. Extraordinary Items

I.e. only the types of income from normal operations

Formula: net profit margin

How can it be refined? Regarding taxes?

Net Income before minority share of earnings, equity income and nonrecurring items / Net sales

By removal of "other" income or expenses in net of its effective tax rate.

Define: Total Asset Turnover. Formula?

How can it be refined?

A measurement of asset activity and their ability to generate sales

Net Sales / Average Total Assets

Removal of assets not linked to net sales. E.g. investments and construction in progress.

Define: return on assets. Formula?

What is its difference between total asset turnover?

The ability of a firm's assets to generate profits.

Net Income before Minority Share of Earnings, Equity Earnings and Nonrecurring Items / Average Total Assets

Total asset turnover uses net sale, not income.

What are the best-figures used for analysis of balance sheet items? Why?

What is a problem with this and what is the solution?

Month-end figures as they account for the seasonal changes in the interim.

As only the beginning and ending figures are published, an average of multiple years is difficult to obtain. Hence, the ending balance sheet figure can be used.

Define: DuPont Return on Assets. Formula? What and how is it used?

It is an analysis of the return on assets by breaking it down to net profit margin and total asset turnover. This way, changes can be more effectively analyzed.

Net profit margin * total asset turnover

What is a variation in DuPont analysis?

Only using the operating accounts and income in order to derive more meaningful ratios

Formula: operating income margin, operating asset turnover and return on operating assets

1. Operating Income / Net Sales

2. Net Sales / Average Operating Assets

3. Operating Income / Average Operating Assets

What do operating assets exclude?

1. Construction in Progress

2. Long-term investments

3. Intangibles

4. Other assets

Formula: DuPont Return on Operating Assets

Operating Margin * Total operating asset turnover

Formula: sales to fixed assets. What does it exclude? Definition? When is it less meaningful?

Net Sales / Total fixed assets. It excludes construction in progress

It measures a firm's plant, property and equipment's ability to generate sales. It is less meaningful when a firm has old fixed assets or is labor-intensive (i.e. low fixed assets).

Define: return on capital.

Return on capital: ratios which show a firm's ability to reward long-term investors

What does a higher return on equity compared to return on investment imply?

The use of funds are profitable meaning that the return from funds from creditors are greater than the interest paid to them.

What are the relationships between profitability ratios?

Return on assets: lowest; accounts for all suppliers of funds

Return on investment: higher than ROA as short-term funds paid is low

Return on equity: higher than previous two as only accounts for equity. ROE > ROI implies a profitable use of funds

Return on Common Equity: highest form of risk; highest reward

Formula: gross margin

Ratio of gross profit to sales

If gross margins decrease, what are the possible reasons?

1. Cost of goods are increasing

2. Sales are declining

3. Sales mix is shifted to contain more products with lower margins

4. Theft

Gains and losses from prior periods, how are they charged? How are they used in analysis?

Charged to retained earnings. If material, it is considered in analysis.

If Net Profit Margin decreases what does this imply? What about asset turnover?

NPM: Expenses increased

ATO: sales generation is inefficient from assets