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Â In this video, we will look at some of the common profitability ratios,

Â like return on equity, return on asset, gross profit margin,

Â operating profit margin, net profit margin, etc.

Â We will continue to use Amazon's financial statements to

Â compute these financial ratios.

Â The first couple of profitability ratios measure how well the company has used its

Â balance sheet resources to generate profit.

Â These two ratios are Return of Equity, ROE, and Return on Assets, ROA.

Â ROE is defined as the net income divided by the average shareholders' equity.

Â The denominator is the average over two consecutive years.

Â For 2015, we will average shareholder's equity from the 2014 and

Â 2015 balance sheets.

Â The reason we average over two consecutive years

Â is that this number will change at least a few times in a year.

Â So we won't know the exact level of shareholders' equity on

Â each day during the year as profits are generated.

Â In most cases, when we have one balance sheet item and

Â one income statement item as a part of a ratio,

Â we will use this method of averaging for the balance sheet item.

Â To calculate Amazon's ROE for 2015,

Â we know that its net income for 2015 is $0.60 billion.

Â Its average shareholders' equity for 2015 is $12.06 billion.

Â Dividing $0.60 billion by $12.06 billion,

Â we get an ROE of 0.494 or 4.94%.

Â For every dollar of shareholders' equity,

Â Amazon earned a little less than $0.05 in profits.

Â Similar calculations yield ROEs of negative 2.35%,

Â 3.05% and negative 0.49%, respectively, for 2014, 13 and 12.

Â This shows that Amazon's profitability has not

Â been very stable over the last few years.

Â And that it has been at its most profitable in 2015.

Â The next profitability ratio is ROA.

Â It is defined as a company's net income divided by its average total assets.

Â Average total assets are defined much like average shareholders' equity for ROE.

Â In 2015, Amazon's net income was $0.60 billion and

Â its average total assets were $59.97 billion.

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Dividing the net income by the average total assets, Amazon's ROA for

Â 2015 works out to be 0.99%.

Â Every $1 in assets owned by Amazon in 2015 generated profits of less than $0.01.

Â But similar to ROE, 2015 was the most profitable year for

Â Amazon over the last four years.

Â But its profitability changes quite dramatically every year.

Â Now other types of profitability ratios are all based only on income

Â statement items.

Â This gives us an idea as to how well the company is managing its costs and

Â hence maintaining its profitability.

Â The first of these ratios is a gross profit margin, or gross margin.

Â The gross margin is the ratio of the company's gross profit for

Â the year divided by its revenues for the year.

Â Gross profit is the difference between revenues and cost of goods sold, COGS.

Â The gross margin tells us how well the company has managed its manufacturing

Â costs or direct costs incurred in the delivery of its services.

Â Companies would like the gross margin to be higher.

Â In 2015, Amazon had revenues worth $107.01 billion and

Â COGS worth $71.65 billion.

Â Its gross profit was $35.36 billion, which when divided by its revenues and

Â expressed as a percentage, use a gross margin of 33.04%.

Â Comparing Amazon's gross margin over the last four years,

Â you can see that is has consistently increased every year since 2012.

Â You can add its variables and COGS, both have increased over the last four years.

Â But revenues have increased at a faster rate than COGS,

Â leading to an increase in gross margins over time.

Â The next profitability ratio is the operating profit margin

Â which is defined as the operating profit divided by revenue.

Â Operating profit is also known as EBIT, earnings before interest and taxes.

Â Amazon's EBIT in 2015 was $2.23 billion and its revenue was $107.01 billion.

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This gives us an operating profit margin of 2.09%, which is, again,

Â the highest in the last four years.

Â The fifth profitability ratio is the pretax margin,

Â which is the earnings before taxes divided by revenues.

Â Amazon's earnings before taxes in 2015 were $1.57 billion.

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Dividing this by its revenues of $107.01 billion gives

Â the pretax margin to be 1.47%.

Â Yet again, this is the highest in the last four years.

Â The final profitability ratio we look at is the net profit margin or net margin.

Â It is the net income divided by revenues.

Â Amazon's net income in 2015 was $0.6 billion.

Â Dividing this by revenues of $107.01 billion gives

Â Amazon's net profit margin to be 0.56%, again, the highest in the last four years.

Â Based on all the profitability ratios, it appears that Amazon is doing well

Â in the most recent year compared to its recent past.

Â Though its gross margin is 33.04%, its net margin is only 0.56%.

Â Amazon's COGS is two-thirds of its revenues,

Â whereas its other expenses account for almost all of the remaining one-third.

Â To get a better sense of whether these ratios are too high or

Â too low, Amazon's ratios should be compared to those of its competitors.

Â In the next video, we will look at some of the more popular activity ratios.

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