Profitability Ratios

1.
Profitability Ratios
Profitability rations refers to a class of financial measures which are used to assess the
ability of a business to generate earnings as compared to its revenues, operating costs, balance
sheet assets, or shareholder’s equity over a given period of time using data obtained from a
specific period of time. As shown above the profitability ratios include the gross margin ratio,
net profit margin ratio, return on capital employed, return on equity and earnings per share.
Profitability Ratios 2021 2020

(Gross Profit/Net
6 Gross Profit Margin Ratio Sales) 0.39 0.30 Good
(Profit after tax /Net Good in
7 Net Profit Margin Ratio sales) 0.34 0.07 2021
(EBIT(1-T)/Net
8 Return on Capital employed Assets 0.41 0.20 Okay
(Profit after Good in
9 Return on Equity taxes/Net worth) 0.34 0.09 2021
EPS = Profit after
tax/No. of common Good in
10 Earnings per share shares outstanding 218.30 -5.70 2021
Table 1: Profitability ratios
1.2. Gross profit margin ratio
The gross profit margin ratio indicates the percentage of sales revenue which a business keeps
after it has covered all the direct costs which are associated with business running. It is computed
by subtracting all direct expenses from net revenue then the result is divided by net revenue and
then converted into a percentage. From our analysis SSE plc the gross profit margin ratio
improved from 30% to 0.39 % respectively. Various scholars argue that a good profit margin is
varied , a 10% profit margin is seen as average while , a 20% margin is viewed as good while a
5% margin is observed as very low. Therefore SSE is considered to have very high gross profit
margin and based on the idea that it is improving then we can firmly argue that the company’s
profitability is promising into the future.
1.3. Net profit margin ratio
This is the ratio of net profits to revenues for a business or a company. When it is expressed
as a percentage, the net profit margin indicates the amount of profit which is generated from each
pound of sales made. This is after accounting for each and every business expense that was
involved in earning the revenues. Similar to gross margin, a good net profit margin ranges from
10% from net profit margin is seen as average , while a 20% margin is seen as high while
anything above 20% is observed to be very high. From the financial analysis, the net profit
margin ratio for SSE plc, the profit margin ratio has improved from 0.07 to 0.34 which very
commendable. This is because, in the year 2020 the net profit margin is observed to be 7%
which is less than average while in the year 2021 the margin has improved almost four times
and above the 20% high level. Therefore its performance in the year 2021 is considered very
high.
1.4. Return on capital employed
Return on capital employed is computed through division of earnings before interest and tax
(Operating profit) by capital employed. It can also be calculated by the dividing the operating
profit by the net assets (Difference between total asset and Current Liabilities). Based on a rule
of thumb, return on capital employed is 15% or more which shows that the business’s quality is
decent and this is certain to suggest that it is generating a return that is well above the weighted
average cost of capital. This ratio is normally made up of two segments, that is the return and
the capital used and it is commonly used to measure return on operating profit. From the
computation of the return on capital employed of SSE plc, we have determined that it increased
from 0.20 to 0.41 which basically translates to 20% and 41% respectively. This shows that the
15% benchmark has been outlived by the company for both years and therefore the company’s
profitability is promising into the next financial year.
1.5. Return on equity
The return on equity ratio is another profitability ratio measuring the potential of a firm
to generate profits from the investments of the shareholders in the company. Moreover, the
return on equity ratio indicates the amount of profit that every pound of common stockholder
equity is able to generate. It is basically used to compare the financial performance of a
company in the same industry just like return on capital employed. Scholars argue that a return
on equity of between 15-20% is considered to be generally good. Based on these arguments we
conclusively say that in 2020 the company’s ROE was not promising as it was below the 15-
20%. Whereas in 2021 the return on equity was very much promising since it grew from 9% to
34%.
1.6. Earnings per share
To find the earnings per share we divide the total annual net income of the last year, by
the total amount of shares outstanding. Stocks with 80% earnings per share are considered to be
one of the best chances of company’s success. Nonetheless, companies are likely to boost their
earnings per share by ensuring that that they buy back their stocks which reduce the amount of
shares outstanding. From our analysis earnings per share in the year 2020 was -5.7 suggesting
the company incurred a loss probably as a result of covid-19. However, in the year 2021 the
earnings per share increased tremendously up to 218.30 suggesting that the company is very
attractive to shareholders into the foregoing.
2. Future performance projection
Into the future the organization is seen to have the potential of generating more profit and
generating more cash flows. The company is anticipated to maintain its liquidity since the
uncertainties associated with the future are not as to ugh as the ones that are associated with the
advent of covid-19. Based on the future plans of the company and its performance in the past the
company is anticipated to improve its revenue generation and hence net income. Based on our
keen observation the company made up about 49% of the operating profits last year, however the
management is planning to increase its capacity five times by the year 2030. This is a
representation of a market increase in revenue. In the past the company is seen to struggle with
improving its earnings before interest and tax depreciation and amortization hence making the
company to rely on asset sales to generate asset sales.

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1.

Profitability Ratios 2021 2020

1.2. Gross profit margin ratio

profitability is promising into the future.

1.3. Net profit margin ratio

1.4. Return on capital employed

profitability is promising into the next financial year.

1.5. Return on equity

equity is able to generate. It is basically used to compare the financial performance of a

on equity of between 15-20% is considered to be generally good. Based on these arguments we

1.6. Earnings per share

attractive to shareholders into the foregoing.

2. Future performance projection

company to rely on asset sales to generate asset sales.

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