Profitability ratios are used to assess the ability of a business to generate earnings as compared to its expenses and other relevant costs over a specified time frame.
Some background knowledge is necessary in order to make relevant comparisons when analysing ratios. For instance, the retail industry typically experiences higher revenues and profits for the Christmas season.
Therefore, it would not be too useful to compare a retailer's fourth-quarter profit margin with its first-quarter profit margin.
On the other hand, comparing a retailer's fourth-quarter profit margin with the profit margin from the same period a year before would be far more informative.
Some examples of profitability ratios are:
|
Gross margin % |
Gross margin (expressed in $)
/
Sales revenue (expressed in $) |
The margin earned from every dollar of sales after deducting the cost of producing the product/services sold |
|
Return on marketing spend % |
Increase in sales revenue (expressed in $)
/
Marketing cost (expressed in $) |
An indicator of the effectiveness of marketing activities over time |
|
Staff costs ratio % |
Staff costs (expressed in $)
/
Sales revenue (expressed in $) |
Staff costs compared to sales revenue |
|
Operating profit % |
Operating profit (expressed in $)
/
Sales revenue (expressed in $) |
The percentage of operating profit the business generates from each dollar of sales |
|
Breakeven point $ unit sales |
Fixed costs (expressed in $)
/
Gross margin (expressed in %) |
The number of unit sales required (at the current gross margin %) to reach a point of $0 profit. Unit sales above breakeven increase the level of profit |
|
Safety margin % |
Sales revenue (expressed in $)
/
Breakeven sales (expressed in $) |
A measure of how far above breakeven the business is trading. The further above 100% the safety margin is, the higher the profit |