Profitability Ratios Definition
Profitability ratios are used to measure the ability of a business and its management to generate profit.
Popular Profitability Ratios List
A selection of popular profitability ratios from the Double Entry Bookkeeping Ratios Guide.
- Gross Profit Percentage
- Overhead Ratio
- Return on Sales
- Net Profit Ratio
- ROCE – Return on Capital Employed
- Return on Assets ROA
Profitability Ratios Analysis
A ratio should not be viewed in isolation but looked at over a period of time using trend analysis and in comparison to other businesses in your industry.
In addition, in order to give a full picture of what is happening, they should be viewed relative to other ratios calculated for the business such as liquidity ratios, efficiency ratios, leverage ratios, activity ratios, and investor ratios.
A profitability ratio normally measures profit and therefore the higher the value the more profit is being generated and the better the business is performing. There are exceptions, in the examples below the profitability ratio Overheads to Sales, measures overheads as a percentage of sales and therefore a lower value is preferable.
Profitability Ratios Formulas
There are numerous examples of profitability ratios, however, it is important to select the key ratios which relate to your business. The industry sector, size, and complexity of the business will determine the most appropriate ratios to use and many may not be relevant or worth calculating, particularly for a small business.
| Profitability Ratio | Formula |
|---|---|
| Gross Profit % | GP / Sales |
| Return on Sales % | PBIT / Sales |
| Overhead Ratio | Overheads / Sales |
| Net Profit % | NP / Sales |
GP = Gross profit
PBIT = profit before interest and tax
NP = Net profit
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.