The World without Bankruptcy Laws
Bankruptcy is one of the natural states which a company may find itself in. Entrepreneurship is primarily about taking risks. When companies take risks, some of them succeed, whereas others fail. Hence failure is a natural part of the business. However, many critics of bankruptcy laws believe that there isn’t a need for an elaborate […]
The Wirecard and Infosys Scandals are a Lesson on How NOT to Treat Whistleblowers
What is the Wirecard Scandal all about and Why it is a Wakeup Call for Whistleblowers Anyone who has been following financial and business news over the last couple of years would have heard about Wirecard, the embattled German payments firm that had to file for bankruptcy after serious and humungous frauds were uncovered leading […]
Why the Digital Age Demands Decision Makers to be Like Elite Marines and Zen Monks
How Modern Decision Makers Have to Confront Present Shock and Information Overload We live in times when Information Overload is getting the better of cognitive abilities to absorb and process the needed data and information to make informed decisions. In addition, the Digital Age has also engendered the Present Shock of Virality and Instant Gratification […]
Why Indian Firms Must Strive for Strategic Autonomy in Their Geoeconomic Strategies
Geopolitics, Economics, and Geoeconomics In the evolving global trading and economic system, firms and corporates are impacted as much by the economic policies of nations as they are by the geopolitical and foreign policies. In other words, any global firm wishing to do business in the international sphere has to be cognizant of both the […]
Why Government Should Not Invest Public Money in Sports Stadiums Used by Professional Franchises
In the previous article, we have already come across some of the reasons why the government should not encourage funding of stadiums that are to be used by private franchises. We have already seen that the entire mechanism of government funding ends up being a regressive tax on the citizens of a particular city who […]
The ultimate aim of all business is to generate profit. That is what the investors invest for, management plans for and employees execute for.
Two companies may be generating the exact same amount of rupee profits, however that does not mean that they are equally profitable. This is because profit is an output measure. And jumping to a conclusion only by looking at the output and not the input that was used to generate the output would not be very prudent!
The profit numbers are therefore seen in relation to various measures of inputs like capital, equity, assets etc. Each of these measures tell a separate story about how the company is performing specific to the input. Analysts often use these numbers together, connect the dots and find out the true picture of the company’s profitability.
Shareholders want the business to generate as much profit as possible. Debt holders on the other hand are content with enough money to ensure that they get paid. Banks want to know whether the company has been making efficient use of fixed assets before granting a loan to buy another one. Thus different user groups have different needs. Hence there is a need for a wide variety of profitability ratios that serves them.
A careful analysis of the profitability ratios also unearths the drivers of profitability. Analysts can look at the financial ratios of an extended period of time and use correlation analysis to unearth the same. The ability to express the company’s business as an accurate input output model is vital for analysts. This is because they can then guess the input, obtain the output and value the firm based on this information.
Common drivers of profitability include economies of scale, economies of scope, mechanization, automation, investment in brand value etc.
Industries have their specific business cycles. These business cycles have similar duration and the highs and lows that the business will experience can also be gauged fairly accurately. Profitability ratios help in doing the same.
Analysts use ratios from past several years and then conduct a trend analysis to find out the patterns hidden in the data. This helps them find out how the sales are expected to move in the next quarter.
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