# Profitability Ratios in detail

Profitability refers to theÂ financial performance of the business. Those ratios which measure a companyâ€™s ability to generate revenue compared to its expenses and other costs associated with generation of income during that period are called Profitability Ratios .

These ratios show how well a company is able to make profits from its operations.

These ratios are used by investors & creditors to determine useful insights about the financial performance & well being of the business.

#### TYPES OF PROFITABILITY RATIOS –

The profitability ratios are of following 8 types :

1. RETURN ON EQUITY RATIO :- This ratio measures Profitability of equity fund invested the company. It is calculated as â€“

Return on Equity = Net Income Ã· Shareholderâ€™s equity

A higher equity ratio is considered good as it indicates good performance of the company.

1. EARNINGS PER SHARE OR EPS :- EPS is a profitability ratio that measures the extent to which a company earns profit. It is calculated as â€“

Earnings per share = Net Profit Ã· Total no. of shares outstanding

Â

1. GROSS PROFIT RATIO :- The gross profit ratio determines the percentage of disposable income available with the organization to carry out business operations.

Formula :-

Gross profit ratio = Gross Profit Ã· Sales Ã— 100

A high ratio represents the greater profit margin and itâ€™s good for the company.

1. NET PROFIT RATIO :- Net Profit Ratio measures the relationship between Net Profit and Net Sales. It shows the percentage of Net Profit earned on Revenue from Operations.

Net profit ratio = Net Profit / Net Sales x 100

Where ,

Net ProfitÂ = Revenue from Operations â€“ Cost of Revenue from Operations â€“ Operating Expenses â€“ Non-operating Expenses + Non-operating Incomes â€“ Tax

A high net profit ratio is favourable for the business as it indicates positive return in the company.

1. RETURN ON ASSETS :- This ratio determines the companyâ€™s ability to earn a profitÂ in comparison to the total assets employed in the business. It is calculated as â€“

Return on Asset = Net profit after taxes / Total Assets x 100

Â

1. RETURN ON CAPITAL EMPLOYED :- This ratio measures percentage return in the company on the funds invested in the business by its owners. It is calculated as â€“

Return on Capital Employed = Â

Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  Net Operating Profit Ã· Capital Employed Ã— 100

Where,

Capital Employed = Total Assets â€“ Current Liability

1. DIVIDEND PER SHARE :- It calculates the amount of money paid by a company to its shareholders.Â The formula is:-

Â

Dividends per share =

Â Â Total amount distributed to shareholders Ã· Total number of shares outstanding

Â

1. PRICE EARNING RATIO :- Price Earnings Ratio(Â PE Ratio ) is the relationship between a company’s share price and earnings per share (EPS).It is calculated as â€“Â

Price Earning Ratio =Â  Â  Market Price of Share Ã· Earnings per share

This ratio shows if the companyâ€™s stock is overvalued or undervalued.

Thus, in simple words Profitability ratios are those accounting ratios which are used to measure the profitability of the business & show how well a company is able to make profits from its operations.

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