Profitability ratio is used to evaluate the company’s ability to generate income as compared to its expenses and other cost associated with the generation of income during a particular period. This ratio represents the final result of the company.
Importance
Profitability represents final performance of company i.e. how profitable company. It also represents how profitable owner’s funds have been utilized in the company.
Types of Profitability Ratio
- Return on Equity
- Earnings Per Share
- Dividend Per Share
- Price Earnings Ratio
- Return on Capital Employed
- Return on Assets
- Gross Profit
- Net Profit
Return on Equity
This ratio measures Profitability of equity fund invested the company. It also measures how profitably owner’s funds have been utilized to generate company’s revenues. A high ratio represents better the company is. Formula: Profit after Tax ÷ Net worth Where, Net worth = Equity share capital, and Reserve and Surplus
Earnings Per Share
This ratio measures profitability from the point of view of the ordinary shareholder. A high ratio represents better the company is. Formula: Net Profit ÷ Total no of shares outstanding
Dividend Per Share
This ratio measures the amount of dividend distributed by the company to its shareholders. The high ratio represents that the company is having surplus cash. Formula: Amount Distributed to Shareholders ÷ No of Shares outstanding
Price Earnings Ratio
This ratio is used by the investor to check the undervalued and overvalued share price of the company. This ratio also indicates Expectation about the earning of the company and payback period to the investors. Formula: Market Price of Share ÷ Earnings per share
Return on Capital Employed
This ratio computes percentage return in the company on the funds invested in the business by its owners. A high ratio represents better the company is. Formula: Net Operating Profit ÷ Capital Employed × 100 Capital Employed = Equity share capital, Reserve and Surplus, Debentures and long-term Loans Capital Employed = Total Assets – Current Liability
Return on Assets
This ratio measures the earning per rupee of assets invested in the company. A high ratio represents better the company is. Formula: Net Profit÷ Total Assets
Gross Profit
This ratio measures the marginal profit of the company. This ratio is also used to measure the segment revenue. A high ratio represents the greater profit margin and it’s good for the company. Formula: Gross Profit ÷ Sales × 100 Gross Profit= Sales + Closing Stock – op stock – Purchases – Direct Expenses
Net Profit
This ratio measures the overall profitability of company considering all direct as well as indirect cost. A high ratio represents a positive return in the company and better the company is. Formula: Net Profit ÷ Sales× 100 Net Profit = Gross Profit + Indirect Income – Indirect Expenses Example:
| Particulars | Amount |
| Shareholder Equity | |
| Equity Shares, 2346 share outstanding, Par value 0.05 | 118 |
| Paid In Capital | 5858 |
| Retained Earning | 13826 |
| Total Shareholder Equity | 19802 |
| Total Assets | 30011 |
| Current Liability | 8035 |
| Total Sales | 53553 |
| Gross Profit | 16147 |
| Net Operating Profit | 3028.65 |
| Net Profit | 3044 |
Profitability Ratios:
1) Return on Equity = Profit After tax / Net worth, = 3044/19802
= 15.37%
2) Earnings Per share = Net Profit / Total no of shares outstanding = 3044/2346
= 1.30 %
3) Return on Capital Employed =
Net Operating Profit / Capital Employed * 100 =3028.65/(30011-8035)*100 = 13.78%
4) Return on Assets = Net Profit / Total Assets = 3044/30011
= 10.14%
5) Gross Profit = Gross Profit / sales * 100
= 16147/53553*100
= 30.15%
6) Net Profit = Net Profit / Sales*100
= 3044/53553*100
= 5.68%
