What Is the Gross Profits-to-Assets Ratio?

Companies with high gross profits-to-assets ratio tend to perform well.

Businesses and investors use various ratios to measure a company's financial health and profitability. While rarely used, the gross profits-to-assets ratio can help investors accurately predict the future performance of stocks in the market. High gross profits-to-assets ratio generally indicates that a business is financially doing well and that you may benefit from investing in it.

Gross Profits

You can find the gross profit figure on a business' profit and loss statement. It represents the company's entire sales revenue minus the cost the company pays to buy or manufacture the sales goods. The profit and loss statement goes on to deduct operating expenses, such as administrative expenses, interest on loans and rent, from the gross profit figure to get the company's earnings. You would commonly use a business' earnings to determine its future profitability. However, gross profits often measure profitability more accurately.

Assets

A business shows its assets in its balance sheet, which usually consists of two columns: one for its assets and liabilities and another one for its shareholders' equity. A company's assets represent all the items it owns that can benefit the business. The balance sheet usually categorizes assets into current and non-current assets. Current assets include cash or items that the company can turn into cash within one year. Other assets fall into the non-current asset category. The balance sheet usually adds up all the asset values to get the value of the company's total assets.

The Ratio

To find the value of a business' gross profits-to-assets ratio, simply divide its gross profits by its total assets and express the figure as a percentage. For example, a business' profit and loss statement shows that it has gross profits of $500,000 while its balance sheet shows that its assets have a value of $1 million. This company, therefore, has a gross-profits-to-assets ratio of 50 percent (from ($500,000 / $1 million) X 100).

Function

High gross profits-to-assets ratio indicates that a company will have high levels of profitability. It predicts the company's long-term earnings and growth in free cash flow, which is the company's operating cash flow minus capital expenditures. According to MSN Money, the five companies with the highest gross profits-to-assets ratio generate returns that are about 0.33 percent higher each month compared to the five companies with the lowest gross profits-to-assets ratio.

References

• MSN Money; A Better Alternative to P/E or P/B?; John REese; May 2010
• The Ohio State University; The Profit and Loss Statement; Marianne M. Huey
• University of Rochester; The Other Side of Value; Robert Novy-Marx; October 2010
• The Ohio State University; The Balance Sheet; Marianne M. Huey