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Profitability Ratios

Profitability ratios helps to evaulate a company's ability to generate profits from its operations. Profitability ratios targets on a company's return on investment in inventory and other assets. These ratios assists in drawing a clear picture that how well a company can achieve profits from their operations.

Profitability ratios act as in important tool for Investors and creditors of a company to evaluate a company's return on investment based on its relative level of resources and assets. Put simply, profitability ratios can be used to decide if a company is making enough operational profit from their assets. Therefore, profitability ratios relate to efficiency ratios because they give an idea of how well companies are utilising thier assets to bring in profits. The concept and Solvency and Going Concern also depends heavily on profitability ratios.

Mentioned below are ratios that are included in Profitability Ratios.

Gross Margin Ratio

The gross margin ratio or the gross profit margin or the gross profit percentage is a profitability ratio which is calculated by dividing the company's gross profit by its net sales. So the formula we get is:

Gross Margin Ratio = Gross Margin/Net Sales

Profit Margin Ratio

The return on assets ratio or return on total assets is a profitability ratio that measures the net income produced by total assets during a period by comparing net income to the average total assets. In other words, the return on assets ratio or ROA measures how efficiently a company can manage its assets to produce profits during a period.

The formula to calculate return on assets ratio is:

Return on Assets Ratio = Net Income/Avergae Total Assets

Return on Capital Employed (ROCE)

Return On Capital Emplyed is a profitability ratio that helps in evaluating how effectively a company can bring in profits from its capital employed by putting into comaprsion the net operating profit to capital employed. In other words, return on capital employed helps investors as to how many dollars in profits each dollar of capital employed generates.

Return on capital employed is calculated by dividing net operating profit or EBIT by the employed capital. This gives us the formula:

Return on capital emplyed = Net Operating Profit/Emplyed Capital

Return on Equity Ratio

The return on equity ratio or ROE is a profitability ratio that helps analysing the ability of a firm to bring in profits from its shareholders investments in the company. Simply put, the return on equity ratio displays how much profit each dollar of common stockholders' equity generates.

The formula to calculate Retrun on Equity Ratio is:

Return on Equity Ratio = Net Income/Shareholders Equity


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