Profitability Ratios Definition

Profitability ratios are a class of financial metrics that are used to assess a company’s ability to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders’ equity.

There are a number of different profitability ratios, each of which looks at a different aspect of the company’s business. The most common profitability ratios are:

Gross margin: This is the ratio of gross profit (revenue less cost of goods sold) to revenue. A higher gross margin indicates a more profitable business.

Operating margin: This is the ratio of operating income (income from operations less selling, general, and administrative expenses) to revenue. A higher operating margin indicates a more profitable business.

Net margin: This is the ratio of net income (income after taxes) to revenue. A higher net margin indicates a more profitable business.

Return on assets (ROA): This is the ratio of net income to total assets. A higher ROA indicates a more profitable company.

Return on equity (ROE): This is the ratio of net income to shareholders’ equity. A higher ROE indicates a more profitable company.