Join Your Exam WhatsApp group to get regular news, updates & study materials HOW TO JOIN

4 Profitability Ratios Every Business Must Calculate

4 Profitability Ratios Every Business Must Calculate

Investopedia defines Profitability Ratios as, “A class of financial metrics that are used to assess a business’s ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor’s ratio or the same ratio from a previous period is indicative that the company is doing well.”

Profitability Ratios Help In:

• Gauging business performance
• Taking business decisions related to expansion or diversification
• Enabling lenders/investors get a clear picture of the business and make available additional resources

The important profitability ratios are:

Gross-Profit Ratio:

• Gross-Profit ratio shows how profitable your company utilizes its resources, materials, and labour
• It measures your business’s manufacturing and distribution efficiency during the production process
• Gross-Profit ratio is calculated as gross profit divided by total sales (revenue)
• A higher Gross-Profit ratio indicates that the business is cost-effective. Note that investors use the gross-profit ratio to compare the profitability of business’s in the same industry and also in different industries

Net-Profit Ratio:

• Net profit ratio is a key ratio of profitability
• It shows the amount of each sales rupee left over after all expenses have been paid
• Calculated as Profit (after tax) / Revenue
• A higher net profit ratio means that your business is more efficient at converting sales into actual profit

Operating Ratio or EBIT (Earnings Before Interest and Taxes):

• EBIT measures an entity’s profitability after excluding interest and income tax expenses
• It represents your business’s earning power from on-going operations.
• Calculated as Profit (loss) + Operating costs + Income tax expense

Cash Flow Margin Ratio:

• Cash-Flow Margin ratio is a key profitability ratio that gives insight into your company’s inner workings
• It measures how well the business’s operations are creating cash from sales
• It is calculated as = Cash flows from operating activities / Net sales
• A high cash flow margin indicates efficiency at debts collection and also a high earnings quality.

4 Profitability Ratios Every Business Must Calculate


At CAKART you will get everything that you need  to be successful in your CA CS CMA exam – India’s best faculty video  classes (online or in pen drive) most popular books of best authors  (ebooks hard copies) best scanners and all exam related information  and notifications.Visit and chat with our counsellors  any time. We are happy to help you make successful in your  exams.

Click here to download FREE CA CS CMA books.

Leave a comment

Your email address will not be published. Required fields are marked *