{"id":4545,"date":"2021-09-15T17:55:29","date_gmt":"2021-09-15T12:25:29","guid":{"rendered":"https:\/\/www.tickertape.in\/blog\/?p=4545"},"modified":"2022-05-24T19:17:45","modified_gmt":"2022-05-24T13:47:45","slug":"profitability-ratios","status":"publish","type":"post","link":"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/","title":{"rendered":"Profitability Ratios \u2013 Overview, Types, Formula and How To Calculate It"},"content":{"rendered":"\n<p>All business ventures and entrepreneurs aim for profit. Investors too aim to make profits in line with the growth in prices of the assets they <a href=\"https:\/\/www.tickertape.in\/blog\/why-should-you-prioritise-investing\/\">invest<\/a> in. But, how do you measure profit? How do you stay ahead of other companies and portfolios, and make a comparison? For instance, you calculate the absolute profit, the relative profit, and compare them against a company\u2019s total revenue. The concept of profitability covers all of this. Let\u2019s examine this concept closely in today\u2019s article.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_66_1 counter-hierarchy ez-toc-counter ez-toc-custom ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title \" >Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#What-is-profitability\" title=\"What is profitability?\">What is profitability?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Types-of-profitability-ratios\" title=\"Types of profitability ratios\">Types of profitability ratios<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Gross-profit-margin\" title=\"Gross profit margin\">Gross profit margin<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Net-profit-margin\" title=\"Net profit margin\">Net profit margin<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Operating-profit-margin\" title=\"Operating profit margin\">Operating profit margin<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Return-on-equity\" title=\"Return on equity\">Return on equity<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Return-on-assets\" title=\"Return on assets\">Return on assets<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Earnings-per-share\" title=\"Earnings per share\">Earnings per share<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Dividend-per-share\" title=\"Dividend per share\">Dividend per share<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Price-earnings-ratio\" title=\"Price-earnings ratio\">Price-earnings ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Return-on-Capital-Employed\" title=\"Return on Capital Employed\">Return on Capital Employed<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#EBITDA\" title=\"EBITDA\">EBITDA<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Merits-of-profitability\" title=\"Merits of profitability\">Merits of profitability<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Shortcomings-of-using-profitability-as-a-metric-of-success\" title=\"Shortcomings of using profitability as a metric of success\">Shortcomings of using profitability as a metric of success<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/www.tickertape.in\/blog\/profitability-ratios\/#Bottom-line\" title=\"Bottom line\">Bottom line<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\" id=\"what\"><span class=\"ez-toc-section\" id=\"What-is-profitability\"><\/span><strong>What is profitability?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Profitability is a company\u2019s ability to generate revenue over and above its expenses. It determines a company\u2019s final performance and also states how profitable the company is and how the company\u2019s funds have been utilised.&nbsp;<\/p>\n\n\n\n<p>Profitability ratios help <a href=\"https:\/\/www.tickertape.in\/blog\/what-is-shareholders-equity-overview-components-and-how-to-calculate\/?utm_source=blog&amp;utm_medium=article\">shareholders<\/a>, stakeholders, and analysts to measure the company\u2019s ability for revenue generation. This further helps to cover operational costs, create value, add assets to the balance sheet and analyse the company\u2019s ability to expand and take on projects for future expansion and growth. Furthermore, profitability ratios are also used to compare the performance of companies against each other.<\/p>\n\n\n\n<p>Usually, higher ratios indicate that a company is performing well. In addition to business owners, investment analysts also use profitability ratios&nbsp;to make wise investment decisions with regard to <a href=\"https:\/\/www.tickertape.in\/blog\/equity-share-capital\/?utm_source=blog&amp;utm_medium=article\">equity<\/a> investments.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"types\"><span class=\"ez-toc-section\" id=\"Types-of-profitability-ratios\"><\/span><strong>Types of profitability ratios<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The various ratios and metrics help to compare past data and analyse a company\u2019s strength to survive in a downtime. The various types of ratios are:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Gross-profit-margin\"><\/span><strong>Gross profit margin<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This is a ratio of gross profit to sales. The gross profit <a href=\"https:\/\/www.tickertape.in\/blog\/margin-requirements\/\">margin<\/a> calculates the excess revenue a company over and above the cost of goods sold. Therefore, the formula can also be applied to measure the segment revenue. A high ratio determines a greater profit margin.<\/p>\n\n\n\n<p><strong>The formula to calculate gross profit margin is: (Gross profit \u00f7 sales) \u00d7 100&nbsp;<\/strong><br>Where, Gross profit = Sales + Closing stock \u2013 Op stock \u2013 Purchases \u2013 Direct expenses<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Net-profit-margin\"><\/span><strong>Net profit margin<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>It is a ratio of net profit to sales. Net profit is calculated after reducing the operational costs, depreciation, and <a href=\"https:\/\/www.tickertape.in\/blog\/cash-dividend-vs-stock-dividend\/\">dividend<\/a> from gross profit. This ratio helps to measure a company\u2019s overall profitability involving all direct and indirect costs.<\/p>\n\n\n\n<p>A higher ratio or margin indicates that the company is earning enough not only to cover all its costs but also its payout to its <a href=\"https:\/\/www.tickertape.in\/blog\/shareholders\/\">shareholders<\/a> or re-invest its profit for growth.<\/p>\n\n\n\n<p><strong>The formula to calculate net profit margin is: (Net profit \u00f7 sales) \u00d7 100&nbsp;<\/strong><br>Where, Net profit = Gross profit + Indirect income \u2013 Indirect expenses<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Operating-profit-margin\"><\/span><strong>Operating profit margin<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This represents the percentage of earnings to sales before interest expense and income taxes.&nbsp; Higher margins indicate that a company is eligible to pay its fixed and operational costs. A higher ratio is also a sign of efficient management and determines a company\u2019s ability to survive in economic downtime compared to its competitors.&nbsp;<\/p>\n\n\n\n<p><strong>The formula to calculate operating profit margin is:&nbsp;Operating Profit = Sales \u2013 Expenses excluding interest and taxes<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Return-on-equity\"><\/span><strong>Return on equity<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This <a href=\"https:\/\/www.tickertape.in\/blog\/return-on-equity-ratio\/?utm_source=blog&amp;utm_medium=article\">ratio<\/a> is commonly used in two situations. Firstly, it measures the profitability of <a href=\"https:\/\/www.tickertape.in\/blog\/what-is-equity\/\">equity<\/a> funds invested in a company. Secondly, it measures how profitably the shareowner\u2019s funds are utilised for the company\u2019s revenue generation. A higher ratio indicates a better performing company.&nbsp;<\/p>\n\n\n\n<p>Th<strong>e formula for return on equity is: Profit after tax \u00f7 Net worth&nbsp;<\/strong><br>Where, <a href=\"https:\/\/www.tickertape.in\/blog\/net-worth\/\">Net worth<\/a> = <a href=\"https:\/\/www.tickertape.in\/blog\/equity-share-capital\/\">Equity share capital<\/a>, and Reserve and Surplus<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Return-on-assets\"><\/span><strong>Return on assets<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This formula calculates the earning per rupee of assets invested in a company.&nbsp;<\/p>\n\n\n\n<p><strong>The formula for return on assets is: Net profit \u00f7 Total assets<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Earnings-per-share\"><\/span><strong>Earnings per share<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This ratio helps to measure profitability from the perspective of an ordinary shareholder. A higher ratio indicates better performance.<\/p>\n\n\n\n<p><strong>The formula for <a href=\"https:\/\/www.tickertape.in\/blog\/earnings-per-share\/\">earnings per share<\/a> is: Net profit \u00f7 Total no. of shares outstanding<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Dividend-per-share\"><\/span><strong>Dividend per share<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This ratio takes into account the amount of dividends distributed by a company to its shareholders. If the ratio is high, it indicates that the company has surplus cash.&nbsp;<\/p>\n\n\n\n<p><strong>The formula for dividend per share is: Amount distributed to shareholders \u00f7 No of shares outstanding<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Price-earnings-ratio\"><\/span><strong>Price-earnings ratio<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Investors use this <a href=\"https:\/\/www.tickertape.in\/blog\/pe-ratio\/?utm_source=blog&amp;utm_medium=article\">ratio<\/a> to check a company\u2019s undervalued and overvalued share price. This ratio further also determines the expectation about a company\u2019s earning and payback period to its investors.&nbsp;<\/p>\n\n\n\n<p><strong>The formula for price-earnings ratio is: Market price of share \u00f7 Earnings per share<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Return-on-Capital-Employed\"><\/span><strong>Return on Capital Employed<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>This ratio helps to measure a company\u2019s percentage return on its invested funds.<\/p>\n\n\n\n<p><strong>The formula for calculating return on capital employed is: Net operating profit \u00f7 capital employed \u00d7 100<\/strong>&nbsp;<br>Where, Capital employed = Total assets \u2013 Current liability<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"EBITDA\"><\/span><strong>EBITDA<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><a href=\"https:\/\/www.tickertape.in\/blog\/what-is-ebitda\/\">EBITDA<\/a> commonly measures a company\u2019s performance with others. The formula is widely used in valuation and project financing. It represents earnings before interest, tax, depreciation, and amortisation.<\/p>\n\n\n\n<p><strong>The formula for EBITDA is: Sales \u2013 <a href=\"https:\/\/www.tickertape.in\/blog\/information-on-expense-ratio\/?utm_source=blog&amp;utm_medium=article\">Expenses<\/a>, excluding interest, tax, depreciation, and amortisation<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"of\"><span class=\"ez-toc-section\" id=\"Merits-of-profitability\"><\/span><strong>Merits of profitability<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Profitability helps to determine the pricing of products and services. For any business venture, pricing plays an important role as it not only increases net revenue but also helps to stay abreast of competitors\u2019 pricing and thus helps in creating a pricing strategy.<\/p>\n\n\n\n<p>Higher profitability is a direct sign of higher sales.&nbsp;<\/p>\n\n\n\n<p>Profitability ratios help to analyse a company\u2019s performance and liquidity derived from its income statements. It also determines a company\u2019s strengths and weaknesses and how a company can achieve profit from its operations.<\/p>\n\n\n\n<p>With profitability, you can also analyse investment returns from a business. In other words, you can measure how effectively the company is issuing its resources to generate value and profit. It also indicates if the company\u2019s resources are properly deployed and if it can sustain itself in the future.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"as\"><span class=\"ez-toc-section\" id=\"Shortcomings-of-using-profitability-as-a-metric-of-success\"><\/span><strong>Shortcomings of using profitability as a metric of success<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Profitability cannot predict the future performance of a company as companies are known to window dress their accounting statements.<\/p>\n\n\n\n<p>Profitability cannot compare a company\u2019s performance across different industries. For example, you cannot compare a pharmaceutical company with the FMCG industry.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Bottom-line\"><\/span><strong>Bottom line<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>While analysts use profitability ratios to determine a good proposal for investment choices, banking institutions use these ratio types to determine the creditworthiness of a company in order to sanction loans. Compared to other ratio types, profitability ratios are more important because all businesses ultimately tend to focus on earning profit and creating value for their stakeholders.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Wondering what does profitability ratio mean? Click here to know more about profitability ratios and find out how you can analyse a company&#8217;s performance using it.<\/p>\n","protected":false},"author":54,"featured_media":4512,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"_lmt_disableupdate":"no","_lmt_disable":"no","footnotes":""},"categories":[8,1769],"tags":[768],"acf":[],"modified_by":"Aradhana Gotur","jetpack_featured_media_url":"https:\/\/www.tickertape.in\/blog\/wp-content\/uploads\/2021\/09\/Stock-Market-2.png?wsr","_links":{"self":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/4545"}],"collection":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/users\/54"}],"replies":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/comments?post=4545"}],"version-history":[{"count":6,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/4545\/revisions"}],"predecessor-version":[{"id":8751,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/posts\/4545\/revisions\/8751"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media\/4512"}],"wp:attachment":[{"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/media?parent=4545"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/categories?post=4545"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.tickertape.in\/blog\/wp-json\/wp\/v2\/tags?post=4545"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}