Operating Cash Inflows

Operating cash inflows is a second variable that we must take into account when determining cash flows from the project. It refers to incremental (additional) cash inflows over the duration of the project. The cash inflows do not take into account interest payments and are calculated as follows:

Revenue

LESS: Expenses (excluding depreciation and interest

 

= EBDIT (Earnings before depreciation, interest and taxes)

LESS: Depreciation

 

= EBIT (Earnings before interest and tax)

LESS: Taxes

 

= NOPAT (Net operating profit after taxes)

ADD: Depreciation

 

= OPERATING CASH INFLOWS

 

How to calculate EPS (Earnings per Share)?

Calculating earnings per share (EPS) allows us to understand how much dollars were earned on each outstanding share of common stock.

In summary, in order to find earnings per share (EPS), we need to take earnings available for common stockholders (the bottom line of the income statement ) and divide it by number of shares of common stock outstanding.

Earnings per Share (EPS) = Earnings Available for Common Stockholders/ Number of Shares of Common Stock Outstanding

Therefore, in order to determine EPS (earnings per share), we need to know earnings available for common stockholders. Earnings available for common stockholders are calculated as follows:

Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

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Net Profit Margin Ratio

Net profit margin ratio (NPMR) is one of the profitability ratios and measures how much of each sales dollar is remaining after all costs are deducted. In other words it measures how successful the firm is in terms of its earnings on sales.

Net profit margin ratio (NPMR) = Net Profit/Sales

For example, if ABC has a net profit of $300,000 and sales of $3,000,000. The NPMR is calculated as follows.

= 300,000/3,000,000

= 0.1 or 10%

Test yourself


Dillon Corporation has a net profit of $500,000 and sales of $3,500,000.

Required: Find the Net profit margin ratio (NPMR)

Solution:

The calculation of Net profit margin ratio (NPMR) of Dillon Corporation will be as follows:

= 500,000/3,500,000

= 0.14 or 14%

The higher the Net profit margin ratio (NPMR), the better it is for the company’s health.

Calculating net profit after tax

In summary, to calculate net profit after tax, we need to subtract cost of goods sold, operating expenses, interest and tax from the sales revenue.

To make this calculation, we need to understand the format of the income statement.

Income Statement Format


Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate net profit after tax, all we need to do is to subtract cost of goods sold, operating expenses, taxes and interest from sales revenue.

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Calculating net profit before tax

In summary, to calculate net profit before tax, we need to subtract cost of goods sold, operating expenses and interest from sales revenue. We need to understand the format of the income statement.

Income Statement Format


Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to calculate net profit before tax, all we need to do is to subtract cost of goods sold, operating expenses and interest from sales revenue.

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How to calculate EBIT (Operating Profit)?

In summary, to calculate EBIT, we need to subtract the costs of goods sold and operating expenses from sales revenue.

To determine EBIT (operating profit), we firstly need to understand the format of the income statement.

Income Statement Format


Sales revenue

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, to determine EBIT, all we need to do is to subtract the cost of goods sold and operating expenses from sales revenue.

Other uses for EBIT


1 – Calculate the Operating Profit Margin Ratio = Operating profit (EBIT) / Sales The operating profit margin measures how much of each sales dollar remains after all costs except for interest, tax and preferred dividends are deducted. In other words it measures how efficient the business manages its operations or how efficiently the firm manages its income statement (keeping a healthy balance between sales and costs).

2 – Calculate the Times Interest Earned Ratio = EBIT/Interest

The times interest earned ratio (Interest Coverage Ratio) measures the ability of the enterprise to meet its financial obligations (interest payments on debt that come due).

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Calculating gross profit

Calculating gross profit is simple and straightforward. In summary, we need to subtract cost of goods sold from the sales revenue.

Whilst making this calculation, we need to have a good understanding of the format of the Income Statement, as shown below. More details can be found in the format of the income statement section.

Income Statement Format


Sales revenue

 

LESS: Cost of goods sold

= Gross profit

LESS: Operating expenses

= EBIT (earnings before interest and tax/operating profit)

LESS: Interest

= Net profit before tax

LESS: Taxes

= Net profit after tax

LESS: Preferred stock dividends

= Earnings available for common stockholders

Therefore, all we need to do is to subtract cost of goods sold from the sale revenue. But how do we find the cost of goods sold? To calculate the cost of goods sold, we need to take the following steps:

Cost of goods sold =

Opening inventory

ADD: Purchases

LESS: Closing inventory

Gross profit allows us, among other things, to calculate the Gross Profit Margin Ratio , which is:

Gross Profit Margin = Gross Profit / Sales GPMR measures how much of each sales dollar is remaining after costs of goods are deducted. In other words it measures the relative cost of goods sold.