Profitability ratios are those which measure the operational efficiency of the firm. There are 3 major types of profitability ratios which most of people look into –
1. Gross Profit Ratio – It is defined as ratio which measures the relationship between gross profit and net sales. It is calculated as gross profit/net sales*100.Gross profit can be calculated as Net sales – cost of goods sold. The higher the ratio better it is because it implies that the margins of the company on sales are more.
2. Operating Profit Ratio – It is measured as Operating profit before interest and tax/net sales *100. Operating profit is calculated as gross profit – operating expenses (for example selling, administrative distribution expenses etc….). In other words it measures the operational efficiency of the company and hence higher ratio is indication of the efficiency of the management of the company.
3. Net Profit Ratio – It is calculated as Net Profit after tax/Net sales *100. This ratio indicates the net amount which is available to the owner of the company of firm after paying off all expenses and taxes. Higher ratio indicates the efficiency of the management and amount of profit it has made on a given sales volume.