Profitability Ratios

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What is profitability ratio?

Profitability ratios are the financial metrics. These are used by the predictors and the stakeholders in order to determine and assess the capability of the organization to generate incomes and profits, balance sheet assets, operating costs and shareholders’ equity at a specific period of time. This ratio explains how good the company makes use of its assets and other possessions to yield profits and value of stakeholders. These ratios are very useful when analyzed on making a comparison to the similar companies to the previous periods.

Related article: Solvency Ratios

Type of Profitability Ratios

  1. Return on Equity

The return on equity ratio helps to measures the profitability of the equity funds that have been invested in the organization. It finds out the way in which the owner’s funds have been utilized profitably in order to generate the revenues of the organization. A high ratio reflects that the company is working well.

Formula: Profit after tax/ net worth

Where,

Net worth= equity share capital, and reserves and surplus

  1. Earnings per share

The profitability from the viewpoint of the ordinary shareholder is measured with this. The higher the ratio, the improved the company is:

Formula: net profit/ total no. of shares outstanding

  1. Dividend per share

The amount of dividend that is distributed by the company to its stakeholders is determined through this ratio. Again, if the ratio is high, it shows that the business organization has sufficient cash.

Formula: amount distributed to the stakeholders/ no of shares outstanding

  1. Price earnings ratio

The investor uses this ratio in order to find the underestimated and the overvalued price of the organization. with the help of this ratio, the expectation related to the earnings of the company and the repayment time to the stakeholders.

Formula: market price of share/ earnings per share

  1. Return on capital employed

The return in the company is computed in the form of the percentage on the amount invested in the business by the stakeholders. the higher will the ratio, the more will the company capable to work better.

Formula:

Net operating profit/ capital employed * 100

Equity share capital, reserves, and surplus, debentures or long term loans are covered under the category of capital employed.

Current liabilities deducted from the total assets results in the capital employed.

  1. Return on assets

The return on assets is used to measure the earnings per rupee of the assets that have been invested in the organization by the owners or the stakeholders. Again, if the ratio will be higher the more easily will the company work.

Formula: net profit/ total assets

  1. Gross profit

The marginal profit of the company is measured by this ratio. Segment revenue can be found out by using this ratio. If the ratio will be more, the profit margin will also be greater that is further good for the company.  

Formula: gross profit/ sales*100

  1. Net profit

The overall profitability of the company including the direct and the indirect expenses is determined with this ratio. If the ratio will be higher, it will yield a positive return in the organization.

Formula: Net profit/ sales*100

Net profit= Gross profit+ indirect incomes- indirect expenses

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