Profitability ratio measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity.
Gross Profit Rate = Gross Profit ÷ Net Sales
Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales minus sales returns, discounts, and allowances) minus cost of sales.
Return on Sales = Net Income ÷ Net Sales
Also known as “net profit margin” or “net profit rate”, it measures the percentage of income derived from dollar sales. Generally, the higher the ROS the better.
Return on Assets = Net Income ÷ Average Total Assets
In financial analysis, it is the measure of the return on investment. ROA is used in evaluating management’s efficiency in using assets to generate income.
Return on Stockholders’ Equity = Net Income ÷ Average Stockholders’ Equity
Measures the percentage of income derived for every dollar of owners’ equity.
Who uses the profitability ratio?
These profitability ratios are commonly used by bankers, accountants, financiers and tax authorities. No need to memorize them all. All you have to do is understand them and find them if necessary in a summary table, accompanied by their detailed content.