Analysis of the Operation and Financial Condition of the Enterprise

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Analysis of the Operation and Financial Condition of the Enterprise Profitability of investing (return on investment) – how efficiently the assets havebeen used in profit-making. Financial profitability (return on capital employed) - how much profit has beenmade by the enterprise owners per one unit of capital invested.The group of trading profitability measures includes the following ratios: Profitability of sales; Profitability of operating activities; Gross profit margin.Within the group of the trading profitability measures the return on sales ratio isused most commonly. Profitability from sales is the relation between the financial amountfigure and the volume figure, or - how much profit is gained per each unit of net turnover.Besides, this ratio reflects the profit made as a result of both sales of goods and servicesand the costs and revenues which are not directly attributable to production of goods orprovision of services (miscellaneous extraordinary revenues, taxation payable, transactionswith securities and others). It is calculated as follows:Profit or loss in the reporting periodTrading profitability 100 % (4.25.)Net turnoverNet profit is the share of the enterprise profit remaining at the disposal of anenterprise after tax, while net turnover is revenue from sales of goods and services aftertax, which is estimated based on the sales turnover and value of goods returned.Ratio between profit and the amount of turnover generally describes whether thecompetitiveness of an enterprise has changed compared to the previous year. If this valuehas increased compared to the preceding period, this would indicate that an enterprise hasimproved its competitiveness.Profitability of sales can be increased by reducing the costs, increasing the priceper unit of goods or by speeding up the rate of increase in the amount of goods soldcompared to the rate of cost increases. For example, costs may be reduced by usingcheaper raw materials and components, by automating the production and increasinglabour productivity etc.It is also necessary to calculate the profitability which is unaffected by the taxrates, any interest paid and received etc., but that are only affected by the operating resultsin an enterprise, its pricing policy etc. Therefore, the profitability of operating activities isused in the financial analysis. This measure is used to identify the efficiency of operationsand sales in earning the income and it describes the operating efficiency of an enterprise.Earnings beforeinterest and taxesProfitability of operating activities 100 % (4.26.)Net turnoverEnterprise managers are always interested in the achievement of a higherprofitability of operating activities as this measure reflects the efficiency of the goodsproduction and sales operations in making the profit.One of the measures in analysis of the business financial activities is the grossprofit margin. According to the dynamics of gross profit conclusions can be made aboutthe reasons for the changes. The changes may be due to the following: increase in netturnover as well as the increase or decrease in operating costs.82
Analysis of the Operation and Financial Condition of the EnterpriseGross profit is the excess of net turnover over the production cost of the goodssold. It is calculated as follows:Gross profitGross profit margin 100 %(4.27.)Net turnoverAn increase or a decrease in the gross profit is influenced by two factors: changesin net turnover and changes in the production cost of goods sold. On the other hand, thechanges in these two factors are interrelated with the scope of production, price per unit ofoutput and prime cost per unit of output.Economic or rates of return on assets are the most commonly used profitabilitymeasures and they are calculated in relation to total assets. Return of assets is usuallycalculated according to the following formula:Earningsbeforeinterest and taxReturn on assets 100%(4.28.)Averagevalueof assetsReturn of assets is applied to assess, how efficiently an enterprise has employedits resources (assets) in generation of its income. This measure illustrates thecompetitiveness of an enterprise. The level of competitiveness is determined by comparingthe assets of any given enterprise with the industry average figure.The level of this value depends on the specifics of the industry in which anenterprise operates. The rate of return on assets is considerably higher (compared to theindustry average figure) in enterprises operating in businesses where there is a wide use ofmanual labour, while in businesses involving high levels of capital it is low.Return on assets can be increased by raising the sales price. This is, however, adifficult task in a free market conditions. Only those enterprises that dictate the prices inthe market can afford raising its sales prices and, thus increase their return on assets. Alsoenterprises dealing in manufacturing of some unique products can afford to increase theirsales prices after which the demand is not dependent on the price as the product itself ismore important than the price. Problems may occur for some enterprises due to an increasein the price per unit of goods, because then the net turnover will decline and an enterprisecan become uncompetitive.The most commonly used measures of financial profitability are the return on total capitaland return on equity capital.Return on total capital shows what the amount of profit could be if all of the capitalemployed would be equity capital. However, because it cannot be detected, what share ofprofit has been gained by disbursement of the debt capital, only the interest payable on useof external capital can be seen. It is estimated according to the following formula:Return on total capitalAnnual profit Interest paid 100 % (4.29.)Total capitalThe average value of the total capital is used as the value for denominator. This isbecause the profit has been made over the entire reporting period, while the total capital isshown as of the final day of the period. This means, that within the period an enterprisemay as well have acquired or lost some capital. Thus the profit/loss figure for the reporting83
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Analysis of the Operation and Financial Condition of the Enterprise

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