Income Statement Ratios

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Income statement ratios are simply financial ratios that are calculated from the data given in an income statement. These ratios provide extensive information about a firm’s capability to use the available assets and capital in order to generate revenue and sales. The income statement ratios are an important tool because they allow the users to examine the information provided in the financial statements.

These ratios also allow business owners to compare their companies’ performance in the previous period to that of the current period. With the help of this information, business owners can make informed decisions about any changes they would require to bring into the company's functioning and operations to make it more profitable. Based on these ratios, comparisons between competing businesses can also be made to determine which business is more profitable.

Some of the income statement ratios are as follows:

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Gross-profit ratio: It shows the relationship between gross profit and sales.

\[Gross~profit~ratio~=~\frac{Gross~profit}{Net~sales}\times~100\]
\[Net~sales~=~Sales-Sales~return\]

‍Operating ratio: The ratio measures the portion of a firm's cost of sales and expenses made in carrying out operations in comparison to sales.

\[Operating~ratio~=~\frac{Cost~of~goods~sold~+~Operating~expenses}{Net~sales}\times ~100\]
Here, the \(Cost~of~goods~sold~=~Opening~stock~+~Purchases~+~Direct~exp~\left(Carriage,~wages,~etc. \right)~-~Closing~stock\)

‍or

\[Sales-Gross~profit.\]
\[Operating~expenses=~Office~and~administration~exp.~+~Selling~and~distribution~exp.~\left( including~depreciation \right) \\ +~Discount~+~Bad~debts~+~Interest~on~short-term~loans\]

‍Net profit ratio: This ratio shows the association between the net profit and sales. It can be calculated as follows:

\[Net~profit~ratio~=~\frac{Net~profit}{Net~sales~~~}\times ~100\]

Earnings per share: It is used to judge the overall profitability of a company. This ratio calculates an entity’s profitability, especially comparing one investment company with another.

\[E.P.S.~=~\frac{Net~profit~\left( after~interest,~tax,~and~dividend~on~preference~shares \right)}{~Number~of~equity~shares}\]