what are all the types of profitability ratios use of profitability ratios and how it is calculated

1. PROFITABILITY
RATIOS
VIKAS KUMAR
1ST M.COM (IB)

2. COMPONENTS USED IN PROFITABILITY
RATIOS:
• SALES FIGURE,
• TOTAL ASSETS EMPLOYED
• NET WORTH ARE USED IN COMPUTATION OF THESE
RATIOS.
Profitability ratios are useful tools to access the
ability of a company to generate profit. These ratios
can also be used to compare a business’
performance against other businesses in same
Definition

3. TYPES OF PROFITABILITY RATIOS
COMMON TYPES OF PROFITABILITY RATIOS
• GROSS PROFIT MARGIN,
• OPERATING PROFIT MARGIN,
• NET PROFIT MARGIN,
• RETURN ON ASSETS, (RETURN ON INVESTMENT) (ROI)
• RETURN ON EQUITY
• RETURN ON CAPITAL EMPLOYED

4. GROSS PROFIT MARGIN-
IT IS CALCULATED AS GROSS PROFIT/ NET SALES *100
WHERE GROSS PROFIT IS CALCULATED AS
• SALES – COST OF GOODS SOLD
• NET SALES IS CALCULATED AS TOTAL SALES – SALES RETURN.
• THIS RATIO COMES IN PERCENTAGE FORM AND HIGHER THE RATIO THE BETTER IT
IS FOR THE COMPANY.

5. OPERATING PROFIT MARGIN
• IT IS CALCULATED AS OPERATING PROFIT/ NET SALES *100
• WHERE OPERATING PROFIT IS CALCULATED BY ADDING NON-
OPERATING EXPENSES AND DEDUCTING NON-OPERATING INCOME
FROM NET PROFIT.
• THIS RATIO TYPICALLY MEASURES THE OPERATING PERFORMANCE
AND EFFICIENCY OF THE COMPANY.
• A HIGHER NET PROFIT RATIO BUT LOWER OPERATING PROFIT
RATIO IS INDICATIVE OF THE POOR OPERATIONAL PERFORMANCE
OF THE COMPANY
• AS PROFIT HAS INCREASED DUE TO OTHER INCOME AND NOT DUE

6. NET PROFIT RATIO
• IT IS CALCULATED AS NET PROFIT/ NET SALES *100
• WHERE NET PROFIT FIGURE COMES AFTER DEDUCTING ALL
OPERATING AND NON-OPERATING EXPENSES FROM GROSS
PROFIT FIGURE AND ADDING NON-OPERATING AND
OPERATING INCOME TO GROSS PROFIT FIGURE AND NET SALES
FIGURE REMAIN SAME AS USED IN GROSS PROFIT FORMULA.
• HIGHER THE RATIO THE BETTER IT IS, HOWEVER, THIS RATIO
WILL ALWAYS BE LOWER THAN GROSS PROFIT RATIO.

7. RETURN ON INVESTMENT
• THE RETURN ON ASSETS RATIO IS AN IMPORTANT PROFITABILITY RATIO
BECAUSE IT MEASURES THE EFFICIENCY WITH WHICH THE COMPANY IS
MANAGING ITS INVESTMENT IN ASSETS AND USING THEM TO GENERATE
PROFIT.
• IT MEASURES THE AMOUNT OF PROFIT EARNED RELATIVE TO THE FIRM'S
LEVEL OF INVESTMENT IN TOTAL ASSETS. THE RETURN ON ASSETS RATIO IS
RELATED TO THE ASSET MANAGEMENT CATEGORY OF FINANCIAL RATIOS.
• THE CALCULATION FOR THE RETURN ON ASSETS RATIO IS: NET
INCOME/TOTAL ASSETS = _____%. NET INCOME IS TAKEN FROM THE
INCOME STATEMENT AND TOTAL ASSETS IS TAKEN FROM THE BALANCE
SHEET.
• THE HIGHER THE PERCENTAGE, THE BETTER, BECAUSE THAT MEANS THE

8. RETURN ON EQUITY
• IT IS CALCULATED AS NET PROFIT AFTER PREFERENCE DIVIDENDS/
SHAREHOLDERS EQUITY
• WHERE SHAREHOLDERS EQUITY IS CALCULATED BY SUBTRACTING TOTAL
LIABILITIES FROM TOTAL ASSETS.
• THIS RATIO MEASURES HOW THE COMPANY IS USING THE SHAREHOLDER’S
FUND AND HIGHER THE RATIO THE BETTER IT IS AS FAR AS INVESTORS ARE
CONCERNED.
• HENCE IN A WAY THIS RATIO IS MORE USEFUL FOR INVESTORS THAN THE
COMPANY BECAUSE IT HELPS THE INVESTORS IN KNOWING WHETHER THEIR
CAPITAL IS USED PROPERLY OR NOT.

9. • RETURN ON CAPITAL EMPLOYED
• RATIO IS USED TO DETERMINE THE RETURNS THAT A COMPANY IS
GENERATING FROM THE CAPITAL EMPLOYED WITHIN THE BUSINESS.
• THIS RATIO IS USED TO MEASURE THE EFFICIENCY WITH WHICH LONG
TERM CAPITAL IS BEING USED IN GENERATING PROFITS FOR THE
BUSINESS.
• THE RATIO ALSO HELPS TO ASSESS THE ABILITY OF A BUSINESS TO
GENERATE SUFFICIENT RETURNS FOR COVERING COSTS OF ITS CAPITAL
• THIS RATIO EXPRESSES THE PROFIT AVAILABLE TO CAPITAL PROVIDERS
AS A PERCENTAGE OF THE LONG TERM CAPITAL EMPLOYED WITHIN THE
BUSINESS (REGARDLESS OF WHETHER THAT MONEY HAS BEEN SUPPLIED
BY OWNERS OR LENDERS). IT TAKES INTO ACCOUNT SOURCES OF
FINANCE.

10. • THOUGH CAPITAL EMPLOYED IS NORMALLY CALCULATED AS OWNERS’
EQUITY PLUS ALL LONG TERM LOANS AND PREFERENCE SHARE CAPITAL (FOR
COMPANIES ONLY), IT MAY ALSO BE CALCULATED AS TOTAL ASSETS LESS
CURRENT LIABILITIES OR NON-CURRENT ASSETS PLUS NET CURRENT ASSETS.
• ONE WAY OF JUDGING THE ADEQUACY OF A COMPANY’S ROCE IS TO
COMPARE IT WITH THE RETURN WHICH COULD BE EXPECTED FROM A RISK-
FREE INVESTMENT SUCH AS BANK DEPOSIT. IF THE COMPANY IS SEEN AS A
HIGH RISK AS A HIGH RISK INVESTMENT, A COMPARATIVELY HIGH ROCE
MIGHT BE EXPECTED AS COMPENSATION FOR THIS RISK.
• IT IS AN IMPORTANT AND USEFUL MEASURE OF PERFORMANCE AS IT
MEASURES INPUT IN THE FORM OF CAPITAL EMPLOYED AGAINST PROFIT AS
OUTPUT.

11. USES OF THE PROFITABILITY RATIO
• TO THE BUSINESS SECTOR TO KNOW ABOUT THEIR CURRENT POSITION
• COMPARE WITH THE OTHER COMPANY
• TO FIND OUT IN EVERY SECTOR OF THE COMPANY
• TO DEVELOP THEIR PLANING AND CAPITAL MOVEMENTS OF THE COMPANY
• MINIMIZE THE RISKS

12. THANK YOU