Profitability Ratios

Name: Profitability Ratios
Author: Glenn Dickerson

Learn the difference between profitability and sustainability.

Preview the first lesson free — get full access to all 2 lessons.

Course: On-Demand

Profitability ratios are used to determine a business's ability to generate earnings compared to its revenues, operating expenses, assets, and the equity of its shareholders or owners. Let's take a look at margin and return ratios. Understanding margin ratios is key to planning and executing sustainability and for developing growth strategies. Margins document a company's profits, showing them as a percentage of sales. These margins help managers make comparisons to other companies in their industry. The most common ratios used for this type of analysis are gross margin, operating profit margin, and net margin. A gross margin tells managers how much of the profit remains when they account for the costs of sales and of goods sold. Net sales is the revenue earned in a given financial period. COGS is defined as the direct costs associated with producing goods. This margin is calculated before direct costs like sales and marketing. Service companies typically have high gross margins while merchandising businesses usually have lower margins. An operating profit margin measures the profit the company makes on each dollar of sales after taking the variable costs of producing a product into account. It is defined as operating earnings divided by revenue. Operating earnings equals revenue minus the cost of goods sold, cost of labor, and the cost of other day-to-day expenses that were incurred in the normal course of business. This ratio tells management how efficiently the organization is able to generate a profit through its main activities. The higher the ratio, the better. This ratio can be used to compare your company to its competitors but it can't be used to compare it to companies in other industries. An operating margin gives management an idea of how well the company is being run and how likely it is to generate profits from its sales. Operating margin takes all operating costs into account but it excludes any non-operating costs associated with operations that aren't part of the company's profit-generating main operations. Companies and service industries typically have high operating margins because they have fewer assets than manufacturing companies. Operations-intensive businesses typically have lower margins as a result of more competition, uncertain demand, higher overhead, and resource-intensive activities. A net margin measures the company's net income against its revenues. It is defined as a net profit divided by revenue. This margin is presented as a percentage of the revenue that remains after all the business's operating expenses, interest, taxes, and dividends on preferred stock have been accounted for. This ratio helps managers monitor the company's internal operations and determine if there are any inefficiencies that need to be addressed. This usually becomes evident when margins decline over time. When managers see declining margins, they need to determine the cause, which could be declining sales revenues, poor customer satisfaction, or poor expense management.

Beginner Provider : Glenn Dickerson 2 Lessons · 8m in Arabic, German, English, Spanish, French, Portuguese, Chinese

Course Description

These lessons explore how profitability ratios are used to calculate whether a business is generating enough earnings. You will learn about the different types of margin and return ratios. You will also learn how to calculate them for use in evaluating your own business’s profitability. Finally, you will learn about sustainability and its relationship with profitability.

What You'll Learn

Calculate margin ratios to assess business profitability
Calculate return ratios for evaluating earnings
Use profitability ratios to determine whether a business is generating enough earnings
Apply margin and return ratios to evaluate your own business's profitability
Distinguish the relationship and difference between profitability and sustainability

Key Takeaways

Profitability ratios are used to calculate whether a business is generating enough earnings.
The course covers different types of margin ratios and return ratios.
Margin and return ratios can be calculated and applied to evaluate your own business's profitability.
Sustainability has a relationship with profitability, and the two also differ from each other.

Frequently Asked Questions

What will I learn in this course?

You will learn how profitability ratios are used to calculate whether a business is generating enough earnings, the different types of margin and return ratios, how to calculate them to evaluate your own business's profitability, and the relationship and difference between profitability and sustainability.

Which lessons does this course include?

The course includes two lessons: Margin Ratios and Return Ratios.

What types of ratios are covered?

The course covers margin ratios and return ratios.

Can I apply what I learn to my own business?

Yes. You will learn to calculate margin and return ratios for use in evaluating your own business's profitability.