Profitability ratios: 12 ways to measure company performance

Profitability ratios are financial metrics used to assess a company's ability to generate earnings relative to its revenue, operating expenses, balance sheet assets, or shareholders' equity over time.

The profitability ratios are mathematical formulas that allow us to reveal the organisation's financial standing, meaning the efficiency with which the company has used its resources to generate profits.

However, This economic calculation can be carried out based on different items in the balance sheet or the profit and loss account and integrate different elements into its analysis., making the final outcome regarding the company's evolution vary noticeably. For example, a business may prove profitable – understood as receiving gains from an investment – if we analyse the expenses dedicated to producing the good or service against the income received, but it might suffer losses if, when calculating the investment made, we add staff costs, taxes, Bank interest, amortisation, fixed capital…

Hence the importance of To know what the different profitability ratios are and their meaning in order to get a true picture of efficiency of the company in all areas, allowing us to develop a expenditure control and operational strategy .

The most commonly used profitability ratios are: * **Gross Profit Margin:** (Revenue - Cost of Goods Sold) / Revenue * **Operating Profit Margin:** Operating Income / Revenue * **Net Profit Margin:** Net Income / Revenue * **Return on Assets (ROA):** Net Income / Total Assets * **Return on Equity (ROE):** Net Income / Shareholder Equity

Among the formulations to carry out this calculation, the following stand out:

• ROI (Return on Investment). This ratio indicates the profitability that the company obtains on its assets, i.e., the efficiency in the use of assets, and is obtained by dividing earnings before interest and taxes (EBIT) by total assets.

ROI= Gross Profit / Total Assets

• ROE (Return on Equity). This financial profitability ratio is one of the most widely used by the business sector as it shows the net profit obtained in comparison with shareholder investment. It is calculated by dividing net profit (after tax) by equity.

ROE= Net Profit / Own Assets

• ROTE (Return of Tangible Equity). Very similar to the previous one, with the difference that it excludes from capital those intangible elements, such as preference shares or goodwill.

ROTE= Total Profit / Tangible Equity

• ROA (Return of Assets).  Calculate the ratio between the company's performance (or return) and total assets.

ROA= Net Profit / Total Assets

• RORWA (Return on Risk-weighted Assets). This is the risk-adjusted return that relates capital to risk-weighted assets.

RORWA= Net Profit / Risk Weighted Assets

• Net return on assets. It is based on the Dupont system and links the ability of assets to produce profits, regardless of how they have been financed.

Return on net assets= (Net income / Sales) * (Sales / Total assets)

• Gross margin. It approximates the profitability of sales versus cost of sales and highlights the company's ability to meet operating expenses and generate revenues.

Gross Profit = (Sales – Cost of Sales) / Sales

• Debt to Assets. Show the company's level of financial autonomy.

Debt to Assets = Total Liabilities / Total Assets

• Current liquidity. It is one of the most frequent for measuring an organisation's ability to cancel its short-term operations.

Current Liquidity= Current Assets / Current Liabilities

• Net profit on average equity. It is the profitability obtained by the shareholder based on the book value of equity, understood as the capital paid in, plus reserves and undistributed profits.

Net profit on equity = Net profit / Average equity

• Default ratio. In this case, the objective is to know the company's debtor ratio.

Bad debt ratio = Doubtful loans / (total loan portfolio + guarantees + other counterparty risks)

• Return on assets. The ratio that measures a company's profitability of assets, establishing a relationship between net profit and total company assets.

Return on Assets = Net Profit / Total Assets