Profitability ratios relate income statement accounts and categories to show a company’s ability to generate profits from its operations.
Profitability ratios emphasize a company’s return on investment in inventory and other assets. These ratios basically show how well companies can achieve profits from their operations.
Types of Profitability Ratio
Common profitability ratios used in evaluating a company’s performance are as follows,
- Gross Profit Margin (GPM)
- Operating Margin (OM)
- Return on Assets (ROA)
- Return on Equity (ROE)
- Return on Sales (ROS)
- Net Profit
Some Details &Calculation of different types of Profitability Ratio
- Gross Profit Margin
Gross margin gives information about the profitability of goods and services. It tells how much it costs one to produce the product.
Gross Margin = Gross Profit/Net Sales * 100
- Operating Margin
Operating margin takes into account the costs of producing the product or services that are distinct from the direct production of the product or services, such as overhead and administrative expenses.
Operating Margin = Operating Profit / Net Sales * 100
- Return on Assets
It measures how effectively the company produces income into assets.
Return on Assets = Net Income / Assets * 100
- Return on Equity
It measures how much a company makes for each dollar that investors put into it.
Return on Equity= Net Income / Shareholder Investment *100
- Net Profit
This ratio measures the overall profitability of a company considering all direct as well as indirect cost. A high ratio represents a positive return in the company and better the company is.
Net Profit = Gross Profit + Indirect Income – Indirect Expenses