To The Moon

Financial ratios represent one of the key deciding factors in measuring how risky or attractive a business would be. The variety ratios combination would give a wider insight of how the business as a whole is performing when benchmark to similar businesses in terms of performance and sustainability moving forward.

Generally there are 4 categories of ratio analysis:

• Profitability
• Liquidity
• Solvency
• Valuation

Profitability remains one of the key elements in deciding investment factor simply because if a business does not generate profit in its business operations, sooner than later the company woud need to request for external funding via equity or leverage on loans.

Net Profit Margin measure net income against revenue, basically it's a measurement of how much of net income generated from every $1 of revenue. The higher the better since its the net returns that the company can either reinvest back into the business or rewards the shareholders.

Business that generate momentum via economies of scale would pushes costs down and thereby increase its potential profit margin.

Growth companies has such potential since Research and Development (R&D) costs is the initial investment with possible exponential returns, however, such R&D requires continuous investment to stay ahead of the curve which in turn lowering the profitability.

Type of Profit Margin

COGS relates to costs that are directly attributable toward generating revenue, in any case the output of a product or services.

Gross profit margin is obtain before deducting selling, general and administrative costs (SG&A).

Gross profit margin measures its production costs (direct costs) in relation to revenue. Since its measure against production costs, its also consider as a measurement of efficiency.

Service oriented businesses tends to have higher gross profit margin Vs manufacturing businesses which relay heavily on raw materials and heavy investment in machinery and equipments.

Basically revenue is deducted with all the necessary costs incurred in relation to business operations.

Net profit margin may be ‘distorted’ if such outcome includes one off event of gains or losses due to disposal of asset during the period.

To avoid such issue, exclusion of one off event would be ideal to understand and compare business performance during the period.

• As the formula suggest, its the profit before Interest (from loan commitments)
• Depreciation (from the capital expenditure invested being measured over its useful life)
• Amortization (same concept as depreciation but cater for capitalization of goodwill, patents etc)

Its a key measurement against business operational profitability and cash flows it generated.

EBITDA also known as non-GAAP (Generally Accepted accounting Principles) financial figure. Meaning EBITDA does not follow GAAP compliance of reporting its figure presentation.

As it measures the efficiency in terms of its business operation (operational expenses) Vs $ generated from its revenue, benchmark against similar industry would give you an idea of how it perform amongst its peers.

What’s your take on Profitability Ratios?

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