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Sunday, November 7, 2010

Financial Metrics - Net Operating Profit Ratios

To compete effectively an understanding of the profit drivers related to investment, interest, taxes, assets, and sales is critical in the evaluation of the business.  As Charles Sawyer stated, “Profit is the ignition system of our economic engine.”  The following are key ratios to analyze Net Operating Profit:
  • Net Profit on Net Sales
  • Net Profit to Tangible Net Worth
  • Net Operating Profit Rate of Return
  • Management Rate of Return
  • Earning Power

Net Profit on Net Sales - This ratio provides a primary appraisal of net profits related to investment.  Once your basic expenses are covered, profits will rise disproportionately greater than sales above the break-even point of operations.

EAT* / Net Sales = Net Profit of Net Sales Ratio

* EAT = earnings after taxes

Net Profit to Tangible Net Worth - The ratio acts as a complementary appraisal to net profits related to investment.  This ratio sizes up the ability of management to earn a return.

EAT / Tangible Net Worth = Net Profit to Tangible Net Worth Ratio

Net Operating Profit Rate of Return - Your Net Operating Profit Rate of Return ratio is influenced by the methods of financing you utilize.  The ratio employee's earnings before interest and taxes are considered.  Profits are taken after interest is paid to creditors.  A fallacy of omission occurs when creditors support total assets.

EBIT / Tangible Net Worth = Net Operating Profit Rate of Return Ratio

Management Rate of Return - This rate, which you may calculate for your entire company or for each division or operations, determines whether you have made efficient use of your assets.  The percentage should be compared with a target rate of return that you have set for the business.

Operating Income / (Fixed Assets + Net Working Capital) = Management Rate of Return Ratio

Earning Power Ratio - The Earning Power ratio combines asset turnover with net profit rate.  Earning power can be increased by heavier trading on assets, by decreasing costs, by lowering the break-even point, or by increasing sales faster than the accompanying rise in costs.

(Net Sales / Tangible Net Worth) X (EAT / Net Sales) = Earnings Power Ratio

Read more about ratios at:
Financial Metrics - Ratio Analysis Considerations