Profitability Indicator Ratios: Effective Tax Rate
This ratio is a measurement of a company's tax rate, which is calculated by comparing its income tax expense to its pretax income. This amount will often differ from the company's stated jurisdictional rate due to many accounting factors, including foreign exchange provisions. This effective tax rate gives a good understanding of the tax rate the company faces.
As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings had a provision for income taxes in its income statement of $307.30 (income statement), and pretax income of $1,040.70 (income statement). By dividing, the equation gives us an effective tax rate of 29.5% for FY 2005.
The variances in this percentage can have a material effect on the net-income figure.
Peer company comparisons of net profit margins can be problematic as a result of the impact of the effective tax rate on net profit margins. The same can be said of year-over-year comparisons for the same company. This circumstance is one of the reasons some financial analysts prefer to use the operating or pretax profit figures instead of the net profit number for profitability ratio calculation purposes.
One could argue that any event that improves a company's net profit margin is a good one. However, from a quality of earnings perspective, tax management maneuverings (while certainly legitimate) are less desirable than straight-forward positive operational results.
For example, Zimmer Holdings' effective tax rates have been erratic over the three years reported in their 2005 income statement. From 33.6% in 2003, down to 25.9% in 2004 and back up to 29.5% in 2005. Obviously, this tax provision volatility makes an objective judgment of its true, or operational, net profit performance difficult to determine.
Tax management techniques to lessen the tax burden are practiced, to one degree or another, by many companies. Nevertheless, a relatively stable effective tax rate percentage, and resulting net profit margin, would seem to indicate that the company's operational managers are more responsible for a company's profitability than the company's tax accountants.
Profitability Indicator Ratios: Return On Assets
Investopedia explains the definition of exchange-traded mutual ...
A distribution of a portion of a company's earnings, decided ...
A ratio developed by Nobel laureate William F. Sharpe to measure ...
The ratio of an insurance company’s net investment income to ...
A measure of profitability used by an insurance company to indicate ...
The policyholder dividend ratio is a measurement of the profitability ...
Learn about the common trends in the average revenue per user, or APRU, for the telecommunications industry and why ARPU ...
Learn what information is important in fundamental analysis of a publicly traded company and how to use it to assess the ...
Learn to understand why it is important for an investor to understand business accounting to perform investment and credit ...
Learn how to create common journal entries for accrued interest, including adjusting entries and delayed bond issues sold ...