Profitability Measures - Case Study Example

Profitability Measures Q1. Company’s use profitability measures to assess how well they are managed. Companies withthe aim of making profits and surviving in the long-term have to use the best profitability measures if the best decision is to be made. Market capitalization and return on assets are the best profitability measures to use in assessing how best companies are managed. Market capitalization reveals the long-term profitability of the company and aims at maximizing the value of shareholders (Freberg & Boland, 2000).

Maximizing the value of the firm is the major aim of firms. On the other hand, return on assets will show how efficiently and effectively the company’s assets have been used in increasing the company’s returns. From the analysis, it will therefore be feasible to rank the companies in terms of their performance. Q2. Return on equity is a better premise of evaluating the performance of firms than the return on sales. Shareholders who are the providers of capital will only get interested if they get value for their resources.

Return on equity is therefore in line with the firm’s objective of wealth maximization. Return on sales shows the proportion of sales that constitutes the profits to the company. It can be subject to manipulation by the management and therefore not a reliable way of assessing management efficiency (Freberg & Boland, 2000). Managers can alter their revenue sources to include only profitable products and customers rather than all its activities. Margins also depend on the capital base. Q3. It is possible that firms, which are profitable, offer negative returns to their shareholders.

To a nonprofessional this might look ridiculous though it is possible. Profitable firms may have high obligations on repaying their debts or the directors could enjoy high compensation at the expense of the shareholders. Moreover, the large profits could be retained hence making shareholders fail to feel the profitability of the company. All the criteria used in assessing company’s performance have limitations. The best way of ranking effectiveness should be based on the shareholders wealth maximization.

ReferenceFreberg, C., & Boland, M. (2000). Profitability and Risk Measures for Investor-owned Firms. Manhattan, KS: Dept. of Agricultural Economics, Kansas State University. Top of FormBottom of Form