Profitability ratios assist you in determining the return on sales and the capital employed by your business. There are several types of profitability ratios used to analyze the financial performance of companies. Here is a look at their differences and significances.

Gross Profit Margin

Margin ratios show the profitability of your business at different levels of cost. The margins can decrease as different cost levels become considered. Your cost levels include operating and non-operating expenses, taxes, and goods sold. There are four types of margin ratios. The first is the gross profit margin, which measures your company’s gross profit against its sales revenue.

The gross profit margin shows the amount of earnings your company generates once the costs incurred to produce services and goods are considered. If you discover a higher gross profit margin, it means your business is quite efficient in its operations. A higher gross profit indicates your profits are sufficient to cover expenses like operation costs, dividends and depreciation. A higher gross profit also leads to increased net earnings for your company, while a low gross profit suggests a higher expense of goods sold for your business. To work out your business’s gross profit margin, divide the gross profit by the revenue.

Operating Profit Margin

To calculate your operating profit margin, you first need to work out your operating profit. To do that, subtract your firm’s operating costs from its gross profit. Then divide the operating profit by the net sales to calculate your operating profit margin. If the operating margin increases quicker against your gross profit margin, it suggests your business’s management is running efficiently. Conversely, if a lower operating profit margin becomes revealed, it shows the inability of your company’s management to regulate its operation costs.

Pre-Tax Profit Margin

This ratio indicates how interest and non-operating items affect your business’s profitability. To work out the pre-tax profit margin, you first need to calculate your company’s earnings before tax. Divide that number by your company’s revenue to arrive at the ratio figure.

Net Profit Margin

This figure refers to the percentage of profit your firm generates from its revenue streams. That means you can discover the amount of net profit your company can create for each unit of increase in revenue. To calculate your net profit margin, divide your company’s net income by its revenue.

Return Ratios