Profitability Ratios

Profitability ratios are the financial ratios which talk about the profitability of a business with respect to its sales or investments. Since the ratios measure the efficiency of operations of a business with the help of profits, they are called profitability ratios. They are quite useful tools to understand the efficiencies / inefficiencies of a business and thereby assist management and owners to take corrective actions. 

Profitability ratios are the tools for financial analysis which communicate about the final goal of a business. For all the profit-oriented businesses, the final goal is none other than the profits. Profits are the life blood of any business without which a business cannot remain a going concern. Since the profitability ratios deal with the profits, they are as important as the profits.

The purpose of calculating the profitability ratios is to measure the operating efficiency of a business and returns which the business generates. The different stakeholders of a business are interested in the profitability ratios for different purposes. The stakeholders of a business include owners, management, creditors, lenders etc.

Types of profitability ratios:

Profitability Ratios Chart

Profitability Ratio

Formula for Profitability Ratios

Based on Sales:

1. Gross Profit Margin / Ratios:

Gross Profit Margin / Ratios


Gross Profit

Net Sales

2. Net Profit Margin / Ratios:

Net Profit Margin / Ratios


Net Profit

Net Sales

3. Expense Ratio:

Expense Ratio (Ex. Sales and Distribution)


Expenses (Ex. Sales and Distribution)

Net Sales


Based on Investment:

1. Return on Assets (ROA):

Return on Assets


Net Profits

Total Assets

2. Return on Capital Employed (ROCE):

Return on Capital Employed (ROCE)


Net Profits

Capital Employed

3. Return to Equity or Shareholders:

Return on Equity


Net Profits

Shareholder’s Funds

Uses of Profitability Ratios

The profitability ratios are useful to get an insight of a business. It helps an analyst to get an indication on the sufficiency or adequacy of profits. It finds out the rate of return and makes the business comparable to the industry as well as its own past. These ratios are used by banks and financial institutions while lending to the business as the ratios ensures them about the regular payments of interest and installments. Not only the bankers but owners also look at these ratios to know about the fruits, their investment is going to reap. Management follows and analyses these ratios to spot out the lacuna in their operations and thereby bring about the necessary improvements.

Last updated on : August 31st, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Interest Service Coverage Ratio / Times Interest …
  • Margin of Safety
  • Types of Activity /Turnover Ratios
    Types of Activity / Turnover Ratios
  • Advantages and Disadvantages of Acid Test Ratio
    Advantages and Disadvantages of Acid Test Ratio
  • Advantages and Disadvantages of Current Ratio
    Advantages and Disadvantages of Current Ratio
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook

    Related pages

    calculating economic value addedliquidity ratios calculatorwhat is the difference between accrual basis and cash basisaccounts receivable ratio analysisnet profit on sales ratiolong term solvency ratio formulabills receivable meaningequipment lease purchase agreement templatehurdle rate waccdrawing power calculation rbiwhat is pbt in financefactors of macro environmentmanagerial accounting break even pointmeaning of corporate restructuringdisadvantages of bank loanspvif calculatorwhat are fictitious assetsnpv with examplewhat does eps growth meanexplain waccwacc projectadvantages and disadvantages of mergers and acquisitionstax treatment of finance leasesdefine lessee vs lessorhow is payback period calculatedthe accounting equation can be expressed asirr accountingtobin q theorywelfare maximizationifrs impairment testcontribution margin per unit formulacapitalization of interest costtobin's q modelprofit maximising conditionreceivables turnover ratio calculatordebtor collection period definitionformula for irrcycle inventory formularedeemable convertible preference sharesloan tenordebturefinancial irrworking capital to sales ratio formuladefine management accountantamerican depository receiptsliquidity ratio analysis and interpretationwhat is accounting equation definitiontotal assets turnover ratio analysis interpretationoperating income vs ebitdastages in venture capital financingaccelerated depreciation definitiontimes interest earned ratio analysisdividend relevance theory pdfcalculation of gross profit ratiofull recourse factoringdividend payout formuladefinition of owner's equityaverage collection formulapbt formularelevant costs in accountingstock turnover ratio definitionreedemable sharesmodified irr calculatorbeneficiary definition in bankingformula for contribution margin per uniteps advantages and disadvantagesdetachable warrantmirr financial calculatorbep in unitstrade debtor collection periodunderstanding debit and credit in accounting