Seasonal Profitability Ratios

Profitability ratios are ways to measure a company's ability to earn money, in return for its investments. There are a variety of factors that can be used to determine profitability. For example, financial analysts use can use return on equity, or profit to cost as measures of profitability. Regardless of the factor used, these ratios can be a source of comparison between a company and its competitors; is also valuable to review a company's profitability ratio over time to measure performance. For companies with seasonal swings in profit, though, this model may fall short.

Seasonal Companies

Seasonal companies are well-established in the general economy. Examples include retail businesses, landscaping companies and even wedding venue companies. Each of these industries has a particular season when it brings in the majority of profit for the year. Landscaping companies do most of their business in the summer. In fact, many lay off their employees in the winter months, called "seasonal unemployment." In retail business, the trend is also well-pronounced. Most operate at a loss for the majority of the year until "Black Friday," the Friday after Thanksgiving, when the retail season truly begins.

Seasonal Profitability Ratios

When you have a seasonal company, you cannot always compare profitability ratios month-to-month or quarter-to-quarter. A stationery store may be struggling to keep its doors open through November only to find a sudden rush of profits in December. It would be wrong to assume that, because the profitability of the store went up in December compared to November, the trend would continue. Similarly, it would be wrong to assume that, because the profitability of the store went down in January compared to December, the trend will continue in the negative direction. Instead, you must take into account that the business of this store is seasonal.

Interpreting Seasonal Ratios

To interpret seasonal ratios, compare the first quarter of each year (Q1) to the first quarter of the previous year and so on. So, Q1 2010 would be compared to Q1 2011 to determine if the store is growing its profit year over year. In a retail establishment, Q4 is likely the most profitable. It should be compared to Q4 from the previous year, not Q3 from this year in to analyze the correct amount of profit. By comparing November to November, there is a much clearer picture of the store's overall growth.

Negative Seasonal Ratios

The time for concern comes when the quarter to quarter analysis shows a downward trend. For example, if a school supply store has a bad September this year compared to last year, an investor may begin to question the cause for this drop. Then, the investor should look into different companies in the industry to see if their September was also weak. If so, it may be an indicator that the economy, not the store, was at fault for the drop. If other stores in the industry posted good numbers, the individual company may be at risk of losing profitability in the long run.

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