Profitability Ratios

Profitability ratios are financial metrics used to assess a company’s ability to generate profit relative to its Revenue, assets, or Equity. These ratios provide insights into how efficiently a company is performing and its overall financial health.

Examples of Profitability Ratios:

  • Gross Profit Margin: Calculated as (Gross Profit / Revenue) x 100. This ratio indicates the percentage of revenue that exceeds the Cost of Goods Sold.
  • Net Profit Margin: Calculated as (Net Income / Revenue) x 100. This measures how much of each dollar of revenue is converted into profit.
  • Return on Assets (ROA): Calculated as (Net Income / Total Assets) x 100. This ratio shows how effectively a company is using its assets to generate profit.
  • Return on Equity (ROE): Calculated as (Net Income / Shareholder’s Equity) x 100. This indicates how well the company is using shareholders’ funds to generate profit.

Cases:

Consider a company with a revenue of $1,000,000, a gross profit of $600,000, net income of $200,000, total assets of $500,000, and shareholder’s equity of $300,000:

  • Gross Profit Margin: (600,000 / 1,000,000) x 100 = 60%
  • Net Profit Margin: (200,000 / 1,000,000) x 100 = 20%
  • Return on Assets: (200,000 / 500,000) x 100 = 40%
  • Return on Equity: (200,000 / 300,000) x 100 = 66.67%