Profitability Margin measures to determine how much money a firm or business activity produces. It measures the ratio of sales that resulted in profitability. Simply defined, the percentage statistic shows how many cents of profit the company made for every dollar of sales.
Profitability ratios are related to efficiency ratios in that they reflect how successfully business utilize their assets to create profits. Profitability is also crucial in terms of solvency and going concern.
The formulae you’re going to learn may be used to assess a company’s performance and compare it to other firms in comparable situations.
Types of Profitability Ratio
Here are some of the major ratios that investors and creditors use when determining a company’s profitability:
Gross Profit Margin:
The gross profit margin ratio indicates the profit a company makes on its cost of sales, also known as the cost of goods sold. It is a fairly basic concept that informs us how much gross profit our company earns every 1 Dollar of turnover.
The gross profit is the profit we make before deducting any administrative, selling, or other charges. As a result, our gross profit margin should be substantially larger than our net profit margin.
How to Calculate Gross Profit Margin?
Gross Profit Margin Formula:
Gross Profit Margin = Gross Profit / Net Sales * 100
Gross Profit = Sales – Cost of Goods Sold
Operating Margin is a measure for assessing a company’s pricing strategy and operational efficiency.
The operating margin is the percentage of a company’s revenue that remains after paying for variable expenses of production such as labour, raw materials, and so on. A good operating margin is essential for a business to be able to cover its fixed expenditures, such as loan interest.
Analysts can use operating margin to determine how much a firm makes (before interest and taxes) on each dollar of sales. When evaluating a company’s quality using operating margin, it is advisable to look at the change in operating margin over time and compare the company’s yearly or quarterly results to those of its rivals. When a company’s margin grows, it earns more per dollar of sales. The greater the margin, the better.
How to Calculate Operating Margin?
Operating Margin Formula:
Operating Margin = Operating Income / Net Sales
Net Profit Margin:
The net profit margin ratio indicates the amount of net profit made for 1 dollar of turnover earned by a company. That is, after deducting the cost of sales, administrative expenses, selling and distribution charges, and all other expenditures, the net profit is the profit that remains after paying interest, tax, dividends, and so on.
How to Calculate Net Profit Margin?
Net Profit Margin Formula:
Net Profit Margin = Net Profit / Net Sales *100
Net Profit = Gross Profit – Expenses
Earning Per Share Ratio (EPS Ratio):
Each outstanding share of common stock receives a percentage of a company’s profit. EPS is a measure of a company’s profitability.
Earnings per share (EPS) is the profit attributable to shareholders (after deducting interest, taxes, and other expenses) divided by the number of shares outstanding. It is the portion of a company’s profits that is allocated to a single ordinary share.
How to Calculate Earning Per Share Ratio?
Earning Per Share Ratio Formula:
Earnings per Share = Profit Available to Shareholders / Average common shares outstanding
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