How is profitability measured?

Profitability is the ability of a company to generate profit.  Generally, the greater the firm’s ability to control costs in relation to its sales, the greater its returns.  Any ratio that measures a firm’s ability to generate profit at a given sales level by relating a measure of profitability (e.g., gross profit, operating profit or net income) to net sales is a profitability ratio.  The higher the ratios, the better the profitability.

Profitability Ratios → Measure operating success for a certain period of time

The profitability ratios include:

• Gross profit margin – Measure of how well a firm’s revenues (net sales) cover its costs of goods sold:

Gross Profit/Net Sales

• Operating profit margin – Indicates a firm’s profitability from operations without regard to financing and investment policy or tax position:

Operating Profit/Net Sales

• Net profit margin – Relates a firm’s net income to its sales and the ultimate measure of a company’s ability to control costs and expenses:

Net Income/Net Sales