This essay focuses on how well management is using the resources.Various measures of profitability indicate how well management is using the resources
Module 4Profitability Analysis
LO 6Compute and use various ratios to assess profitability.
Creditors are concerned with a company’s profitability. It is because a profitable company is more likely to be able to make principal and interest payments.
Of course, stockholders care about a company’s profitability because it affects the market price of the stock and the ability of the company to pay dividends. Various measures of profitability indicate how well management is using the resources at its disposal to earn a return on the funds invested by various groups. Two frequently used profitability measures, the gross profit ratio and the profit margin ratio, were discussed earlier in the chapter. We now turn to other measures of profitability.
Rate of Return on Assets
Before computing the rate of return, we must answer an important question. This return to whom? Every return ratio is a measure of the relationship between. It is the income earn by the company and the investment made in the company by various groups. The broadest rate of return ratio is the return on assets ratio because. This it considers the investment made by all providers of capital, from short-term creditors to bondholders to stockholders. Therefore, the denominator, or base, for the return on assets ratio is average total liabilities and stockholders’ equity—which, of course, is the same as average total assets.