The main purpose of a company to carry out its operational activities is to gain profit. Through the products or services they offer, the company will do various strategies in making profits. In accounting, there is one ratio that can be used to analyze a company’s ability to make a profit. This ratio is known as the profitability ratio.
You should know exactly how to calculate the profitability ratio. Therefore, to make this easier, you can use Accounting Software as a solution to simplify your financial calculations, including business profitability ratios. What is the profitability ratio? What are the advantages of profitability ratio? Check out this article to know more about it!
Table of Content
Profitability Ratio Definition
The profitability ratio has an understanding as a ratio to measure a company’s ability in earning profits. In other words, this ratio can have a definition as a step to know how effective the company is in carrying out its operational activities. One of the experts, Irham Fahmi, said that the profitability ratio measures a company’s ability to gain profits on certain sales, assets, and stock capital.
Also Read: Calculate EBIT to Determine Your Company’s Profitability
Profitability Ratio Benefits
The advantages of the profitability ratio are numerous for its users. With the profitability ratio, users can calculate their profit at a certain period. The company can assess the company’s profit position in the previous period with the current period. Also, the other benefits of profitability ratios are to assess a company’s net income amounts after taxes with the company’s capital. No less important, business profitability ratios can help companies measure the used funds’ productivity. Assisted by CRM-Sales Software that will optimize cash flow on time, reduce manual processes, and focus on sales. Also, can calculate sales commissions accurately based on sales targets achieved by each salesperson.
Profitability Ratio Types and Formulas
After knowing the definition and benefits of profitability ratios, you must know the profitability ratio types. Ranging from gross profit margin to return on capital employed. Here is the explanation of each type and the formula.
Gross profit margin
You can assess the gross profit percentage towards the sales revenue with gross profit margin. In this case, the bigger the gross profit margin, the company’s operational activities can say to be more efficient. In contrast, if the gross profit margin is getting smaller, the company’s operational activities can be said to be less efficient. Furthermore, here is the formula for calculating gross profit margin:
Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue x 100
Net profit margin
The net profit margin is one of the profitability ratio types that can analyze and assess the company’s net income. The calculated net income is the percentage after-tax deduction towards the company’s sales revenue. If the net profit margin is high, then it can say that the company’s operational activities are running well. Furthermore, here is the formula for calculating net profit margin:
Net Profit Margin = Net Profit/Total Revenue x 100
Return on asset
Return on the asset has a function to assess the company’s profit percentage related to resources or total assets. Therefore, the return on assets will show the company’s efficiency in managing its assets. Furthermore, here is the formula for calculating return on assets:
ROA = Net Income / Total Assets
Return on equity
This profitability ratio type can analyze a company’s ability to gain profits from the company’s shareholders’ investment. Therefore, return on equity can be calculated from the company’s income towards the capital invested by the company’s owner. Furthermore, here is the formula for calculating return on equity:
ROE = Net Income / Shareholder Equity
Return on sales
Return on sales has a function to show the company’s profit level after making various payments of production variable costs. These production variable costs include the raw materials and employee salaries before deducting interest and taxes. Furthermore, here is the formula for calculating return on sales:
ROS = Operating Profit/Net Sales
Return on capital employed
This profitability ratio type can assess the company’s profit from the capital that has been used. In this case, capital is the company’s equity coupled with non-current liabilities. With this type, the company’s capital efficiency and profitability can be seen. Furthermore, here is the calculation formula:
ROCE = Earning Before Interest and Tax (EBIT)/Capital Employed
Also Read: Tips to Start a Successful Catering Services
Conclusion
The profitability ratios can provide convenience for your company in knowing the earned profit amount in one period. This ratio can also know the productivity of all used company funds. This ratios have various types, ranging from gross profit margin to return on capital employed.Â
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