Profitability (収益性) is the business-analysis viewpoint that looks at how much profit a company earns relative to its sales or capital.
It is measured as a ratio of profit to a base amount such as sales or capital, and a higher ratio means a stronger ability to earn. The ratio to sales is the profit-to-sales ratio and the ratio to capital is the return on capital, and return on investment, covered next, is one kind of return on capital. The name of the indicator changes with the profit used as the numerator, such as operating profit or net income for the period.
AnalogyEven with the same day's sales, the shop that keeps more in hand after paying for materials and rent is seen as the stronger earner.
Exam points
ExamThe profit-to-sales ratio (売上高利益率) can be found from the sales and profit on the current period's income statement (損益計算書) alone. Indicators that need the previous period's figures or balance sheet (貸借対照表) figures cannot, and the return on equity (自己資本利益率) is one of them because its denominator, equity, appears on the balance sheet.
ExamBecause the profit margin (利益率) is profit ÷ sales, it rises when profit grows even if sales fall.
Return on investment (投資利益率, ROI) is a profitability indicator that expresses the profit earned on the capital invested as profit ÷ invested capital × 100 (%).
Indicator
Numerator
Denominator
Return on investment (ROI)
Profit
Invested capital
Return on equity (ROE)
Net income for the period
Equity
Return on assets (ROA)
Profit
Total assets
The higher the value, the more profit is earned from less capital. Using equity as the denominator gives ROE (return on equity) and using total assets gives ROA (return on assets), and all of them are returns on capital. A return on capital breaks down into "profit ÷ sales" times "sales ÷ capital", where the former is the profit-to-sales ratio and the latter is the capital turnover ratio.
AnalogyIt works like the interest rate on a deposit: it shows by what percentage the original money grew.
How to rememberThe E in ROE stands for Equity and the A in ROA for Assets. The last letter of the abbreviation tells you the denominator.
Exam points
ExamROE is net income for the period (当期純利益) divided by equity (自己資本), and shows how well the capital put in by shareholders earns.
ExamReturn on capital (資本利益率) = profit-to-sales ratio (売上高利益率) × capital turnover ratio (資本回転率), so knowing any two gives the third. For example, with a return on capital of 9% and a capital turnover of 3 times, the profit-to-sales ratio is 3%.
ExamThe profit in the numerator of return on investment (投資利益率) is the amount gained from the investment minus the costs the investment incurs. When both arise every year, total each over the whole period being evaluated before subtracting.
Efficiency (効率性) is the business-analysis viewpoint that looks at how well a company uses its assets and capital, without waste, to generate sales.
Turnover ratio
Turnover period
How it is expressed
How many times it turns over in a given period
How many days one turnover takes
Unit
Times
Days
Direction of better efficiency
Higher is better
Shorter is better
The typical indicator is the turnover ratio, found by dividing sales by an amount such as capital or inventory, and it shows how many times that amount turns over in a given period. A higher turnover ratio means more sales from fewer assets, which is more efficient. The turnover period, given as the number of days one turnover takes, works the other way: the shorter it is, the better the efficiency.
AnalogyShelves of the same size work harder in a shop where goods keep selling and being restocked.
How to rememberThink of turnover as the spins of a top. The more it spins, the better the efficiency, and the shorter each full turn takes.
Exam points
ExamThe inventory turnover ratio (在庫回転率) is sales divided by average inventory, and the higher it is, the faster stock sells and is replaced.
ExamThe total asset turnover ratio (総資産回転率, sales ÷ total assets) and the turnover period of total assets are inversely proportional: when the ratio doubles, the period halves.
ExamWhen the inventory turnover period (在庫回転期間) is calculated with cost of sales, first find the cost of sales (売上原価). It equals sales multiplied by one minus the gross profit margin (売上総利益率).
Safety (安全性) is the business-analysis viewpoint that looks at whether a company can keep repaying loans and paying bills without delay, that is, its ability to pay and financial stability.
It is judged from the balance between the assets on hand and the liabilities to be repaid, and from the share of capital that is equity, which needs no repayment. The current ratio, covered next, is the typical measure of short-term capacity to pay, and the equity ratio (equity ÷ total capital × 100) is the typical measure of the stability of capital as a whole, and for both a higher value means more safety.
AnalogyHowever high the monthly salary, a household is in danger if its savings cannot cover next month's bills. This viewpoint asks whether payments can keep being made.
Exam points
ExamThe higher the equity ratio (自己資本比率), the larger the share of funds that need no repayment, and the higher the financial safety (安全性).
Mix-upThe equity ratio (自己資本比率), a safety (安全性) measure, and return on equity (自己資本利益率), a profitability (収益性) measure, have similar Japanese names. The former looks at how capital is made up, and the latter at profit relative to capital.
The current ratio (流動比率) is current assets divided by current liabilities, multiplied by 100, and is a safety indicator of short-term capacity to pay.
Example
Current assets
Current liabilities
Current ratio
Example 1
450
300
150% (room to spare)
Example 2
240
320
75% (current assets alone fall short)
Current assets turn into cash within one year and current liabilities must be paid within one year, so the ratio shows how many times over the resources on hand cover what is due soon. A higher value means more room to pay, and below 100% the current assets alone cannot cover the liabilities due soon.
AnalogyIt is like comparing the bills and loan repayments due within the year with your wallet and bank savings plus money a friend will soon pay back and things you will soon sell for cash.
How to remember"Current" means items that flow in or out as cash within a year. The numerator and the denominator are both "current" items, so they match.
Exam points
ExamThe current ratio (流動比率) is current assets (流動資産) ÷ current liabilities (流動負債) × 100. Non-current assets (固定資産), non-current liabilities (固定負債) and net assets (純資産) are not used in the calculation.
ExamThe larger the current ratio, the higher the short-term ability to pay, and the smaller it is, the lower that ability.
Business analysis turns financial statement figures into ratios to assess the ability to earn profit, the efficiency of asset use and the ability to keep paying.
Return on investment is profit ÷ invested capital × 100, and it becomes ROE with equity as the denominator and ROA with total assets.
The higher the turnover ratio and the shorter the turnover period, the more efficiently assets are being used.
The higher the current ratio (current assets ÷ current liabilities × 100) and the equity ratio, the greater the safety.