Profitability Analysis

A growing company with declining operating profit

This is the synthetic Example Company from Financial Ratio Analysis, in EUR thousands. Opening cash is 1,200, receivables 1,000, inventory 800 and PP&E 5,000; payables are 800, debt 3,000 and equity 4,200. Other opening positions are zero.

The three annual forecasts use revenue 10,000 / 12,000 / 13,200; COGS 6,000 / 7,800 / 8,580; overhead 2,000 / 2,400 / 2,904; depreciation 500 / 700 / 900; capex 500 / 1,800 / 1,500. Closing receivables are 1,000 / 1,800 / 2,200, inventory 800 / 1,600 / 2,000, payables 800 / 1,040 / 1,144 and debt 3,000 / 3,500 / 3,500. Tax is 25%, interest is 5% of opening debt, and other transactions and distributions are zero.

Profit margin analysis: where the deterioration enters

From 2026 to 2027, revenue rises by 2,000 but COGS rises by 1,800. Gross profit gains only 200, from 4,000 to 4,200, and gross margin drops five percentage points to 35%. Overhead rises by 400 while staying at 20% of sales. EBITDA therefore falls by 200 to 1,800; its margin falls from 20% to 15%.

From 2027 to 2028, gross margin stays at 35%. Additional revenue adds 420 gross profit, but overhead increases by 504 and reaches 22% of sales. EBITDA falls another 84 to 1,716, or 13% of revenue. The first deterioration enters at direct costs; the second enters at overhead relative to sales.

Depreciation grows from 500 to 700 to 900. EBIT consequently falls from 1,500 to 1,100 to 816, more sharply than EBITDA. This separates the additional non-cash asset expense from the operating-cost changes. The existing Gross Margin, EBITDA and EBIT pages retain their individual calculations.

Bring capital employed into the diagnosis

With other long-term positions zero, invested capital is operating net working capital plus PP&E. Closing net working capital rises from 1,000 to 2,360 to 3,056. PP&E closes at 5,000 / 6,100 / 6,700, reflecting opening assets plus capex less depreciation. Closing invested capital is therefore 6,000 / 8,460 / 9,756.

ROIC uses average opening and closing invested capital: 6,000 / 7,230 / 9,108. Normalized NOPAT is 1,125 / 825 / 612. Dividing gives 18.75% / 11.41% / 6.72%. Lower after-tax EBIT and a larger capital base both depress the result. ROIC explains this basis, including the absence of a tax credit on negative operating earnings.

The statements locate the numerical drivers; they cannot tell us whether lower gross margin came from pricing, product mix or supplier inflation. Nor do rising depreciation and capex alone prove poor investment decisions. Those explanations require operating data and investment timing.

Reproduce the income and return bridge

Create a blank annual model in EUR thousands, starting in 2026, with zero actual years and three forecast years. In Advanced mode enter the opening balances and the annual amounts above. Enter costs, depreciation and capex as positive input amounts. Keep gross margin consistent at 40% / 35% / 35%, and set tax and opening-debt interest to 25% and 5%.

Read Revenue, Gross Profit, EBITDA and EBIT in the Income Statement, then compare EBITDA margin, EBIT margin and ROIC in Metrics. Confirm PP&E and working-capital balances in the Balance Sheet. The model link opens your current model and does not import this example. The Income Statement Model owns forecast construction.

What this page does and does not establish

The diagnosis is falling profit conversion at two different cost layers, amplified in EBIT by depreciation and in ROIC by capital absorption. A margin-only analysis would miss the larger investment base. Return to Financial Ratio Analysis to see the resulting liquidity and leverage signals.

Keep periods, cost classifications and tax conventions comparable. This exercise isolates an accounting bridge; it does not normalize exceptional costs, benchmark competitors or prove a commercial cause.