Measuring Profitability

Measuring Profitability

  • Gross Profit Margin: Key concept in understanding a company’s profitability. Calculated by figuring out gross profit divided by total sales and then turned into a percentage by multiplying by 100. The gross profit margin indicates the percentage of revenue available to cover operating and other expenditures.

  • Net Profit Margin: Also crucial for understanding profitability. Net profit margin is arrived at by taking net income and dividing it by total sales and then multiplying by 100. Reveals how much a company earns, after accounting for all expenses, as compared to its total revenue.

  • Return on Capital Employed (ROCE): An important way to measure profitability and the efficiency with which capital is employed. Calculated through dividing Net Operating Profit by Capital Employed (total assets minus current liabilities). The result shows profitability relative to the size of assets.

  • Operating Margin: Useful for comparing the profitability of different companies within the same industry or in measuring a company’s profitability trend over multiple periods. It’s calculated as Operating Income divided by Net Sales and then multiplied by 100.

  • Earnings Per Share (EPS): Profitability measure that is of importance to shareholders. It tells the amount of profit that is theoretically available to each share of a company’s common stock. It is calculated as company’s net income - dividends on preferred stock / average outstanding shares.

  • PE Ratio (Price to Earnings Ratio): Tells us how much investors are willing to pay for a company’s profit. PE is calculated through dividing market price per share by earnings per share (EPS). The PE ratio helps to provide a meaningful comparison between companies in the same sector or industry.

In conclusion, there are various ways to measure the profitability of a company, and each offer different insights into the financial health and performance of the company. It’s important to use these measures together to get a full picture of a company’s profitability. As always, seek professional advice when needed.