PROFITABILITY IN RELATION TO INVESTMENTS
1. RETURN ON GROSS CAPITAL EMPLOYED
This ratio establishes the relationship between net profit and the gross capital employed. The term gross capital employed refers to the total investment made in business. The conventional approach is to divide Earnings After Tax (EAT) by gross capital employed.
Return on gross capital employed = Earnings After Tax (EAT) X 100 / Gross capital employed
2. RETURN ON NET CAPITAL EMPLOYED
It is calculated by dividing Earnings Before Interest & Tax (EBIT) by the net capital employed. The term net capital employed in the gross capital in the business minus current liabilities. Thus it represents the long-term funds supplied by creditors and owners of the firm.
Return on net capital employed = Earnings Before Interest & Tax (EBIT) X 100 / Net capital employed
3. RETURN ON SHARE CAPITAL EMPLOYED
This ratio establishes the relationship between earnings after taxes and the shareholder investment in the business. This ratio reveals how profitability the owners’ funds have been utilized by the firm. It is calculated by dividing Earnings after tax (EAT) by shareholder capital employed.
Return on share capital employed = Earnings after tax (EAT) X 100 / Shareholder capital employed
4. RETURN ON EQUITY SHARE CAPITAL EMPLOYED
Equity shareholders are entitled to all the profits remaining after the all outside claims including dividends on preference share capital are paid in full. The earnings may be distributed to them or retained in the business. Return on equity share capital investments or capital employed establishes the relationship between earnings after tax and preference dividend and equity shareholder investment or capital employed or net worth. It is calculated by dividing earnings after tax and preference dividend by equity shareholder’s capital employed.
Return on equity share capital employed = Earnings after tax (EAT), preference dividends X 100 / Equity share capital employed.
The following are some of the important and basic concepts to be understood in management accounting:
EARNINGS PER SHARE
IT measures the profit available to the equity shareholders on a per share basis. It is computed by dividing earnings available to the equity shareholders by the total number of equity share outstanding.
Earnings per share = Earnings after tax – Preferred dividends (if any) / Equity shares outstanding
DIVIDEND PER SHARE
The dividends paid to the shareholders on a per share basis in dividend per share. Thus dividend per share is the earnings distributed to the ordinary shareholders divided by the number of ordinary shares outstanding.
Dividend per share = Earnings paid to the ordinary shareholders / Number of ordinary shares outstanding
DIVIDENDS PAY OUT RATIO (PAY OUT RATIO)
It measures the relationship between the earnings belonging to the equity shareholders and the dividends paid to them. It shows what percentage shares of the earnings are available for the ordinary shareholders are paid out as dividend to the ordinary shareholders. It can be calculated by dividing the total dividend paid to the equity shareholders by the total earnings available to them or alternatively by dividing dividend per share by earnings per share.
Dividend pay our ratio (Pay our ratio) = Total dividend paid to equity share holders / Total earnings available to equity share holders
Dividend per share / Earnings per share
DIVIDEND AND EARNINGS YIELD
While the earnings per share and dividend per share are based on the book value per share, the yield is expressed in terms of market value per share. The dividend yield may be defined as the relation of dividend per share to the market value per ordinary share and the earning ratio as the ratio of earnings per share to the market value of ordinary share.
Dividend Yield = Dividend Per share / Market value of ordinary share
Earnings yield = Earnings per share / Market value of ordinary share
PRICE EARNING RATIO
The reciprocal of the earnings yield is called price earnings ratio. It is calculated by dividing the market price of the share by the earnings per share.
Price earnings (P/E) ratio = Market price of share / Earnings per share