 ### Profitability Ratios

Profitability Ratios are used to evaluate management's ability to create earnings from revenue-generating bases within the organization. Profitability Ratios measure the earnings by dividing the earnings by a base, such as assets, sales or equity. Four common profitability ratios are:

Profit Margin on Sales = Net Income / Sales

Operating Margin on Sales = Earnings Before Interest & Taxes / Sales

Return on Assets = Net Income / Average Assets

Return on Equity = Net Income / Average Common Equity

Example : Net Sales (Gross Sales less Allowances) are \$ 500,000.

Earnings Before Interest and Taxes are \$ 50,000 and Net Income is \$ 25,000. Asset Balances are: Beginning \$ 190,000 and Ending \$ 210,000

Common Stock Balances: Beginning \$ 325,000 and Ending \$ 325,000

Retained Earnings Balances: Beginning \$ 100,000 and Ending \$ 150,000.

Profit Margin = \$ 25,000 / \$ 500,000 = .05 or 5%

Operating Margin = \$ 50,000 / \$ 500,000 = .10 or 10%

Return on Assets = \$ 25,000 / (\$ 190,000 + \$ 210,000) / 2 = .125 or 12.5%

Return on Equity = \$ 25,000 / (\$ 425,000 + \$ 475,000) / 2 = .055 or 5.5%

Profitability ratios are widely used by creditors, investors, and others who are interested in finding out how management generates its earnings. Written by: Matt H. Evans, CPA, CMA, CFM | Email: matt@exinfm.com | Phone: 1-877-807-8756