GROSS PROFIT AND OPERATING PROFIT MARGINS

							                          Chapter 4

         INCOME STATEMENT AND PROFIT MARGIN RATIOS


          SALES
                           *
  LESS    PRODUCTION COSTS
         GROSS PROFIT
                                **
  LESS   OTHER OPERATING COSTS
         EBIT (OPERATING PROFIT BEFORE TAXES)
  LESS   INTEREST EXPENSES
         EBT (TAXABLE INCOME)
 LESS    TAXES
         NET INCOME


* PRODUCTION COSTS = COST OF GOODS SOLD (CASH CHARGES)
                   + DEPRECIATION OF PRODUCTION
                     RELATED FIXED ASSETS(NON CASH CHARGES)

** OTHER OPERATING COSTS = SALES & ADMINISTRATION
                           EXPENSES (CASH CHARGES)
                          + DEPRECIATION OF SALES &
                           ADMINISTRATION RELATED FIXED
                           ASSETS (NON CASH CHARGES)



GROSS PROFIT MARGIN              = GROSS PROFIT/SALES

OPERATING PROFIT MARGIN           = EBIT/SALES
   GROSS PROFIT AND OPERATING PROFIT MARGINS

                       AN EXAMPLE
                FIRM         INDUSTRY       COMMENT

SALES          $100 (100%)   $100 (100%)

- PRODUCTION
  COSTS        $ 65 (65%)    $ 60 (60%)         HIGHER*

GROSS PROFIT $ 35            $ 40
(GROSS PROFIT
 MARGIN )         (35%)             (40%)       WORSE*

- S&A COSTS   $17 (17%)       $25 (25%)       LOWER**
 EBIT I.E.
 OP. PROFIT   $18            $15
 (OP. PROFIT
  MARGIN )        (18%)          (15%)      BETTER**
                                                     ***
-INTEREST     $10 (10%)       $6 (6%)        (WORSE)
  EBT         $8              $9
 - TAXES @25% $2               $2.25
NET INCOME     $6              $6.75
                                                       ****
PROFIT MARGIN 6%                6.75%        (WORSE)

  *   DUE TO WEAKER PRODUCTION COST CONTROLS
  ** DUE TO STRONGER S&A COST CONTROLS
  *** DUE TO HIGHER LEVERAGE AND INTEREST COSTS
  **** DUE TO ITEMS 1 AND 3 ABOVE
            DUPONT FORMULA APPLICATION– AN EXAMPLE

                          ROA = NI/TA

                 ROE = ROA * EQUITY MULTIPLIER

#    NI   TA ROA DEBT EQUITY  DEBT   EQUITY    ROE
    $M    $M. %   $M    $M   RATIO% MULTIPLIER %
1    10   100 10    0   100     0        1      10
2    10   100 10   20    80    20      1.25    12.5
3    10   100 10   50    50    50        2      20
4    10   100 10   80    20    80        5      50
5    10   100 10   90    10    90       10     100