Introduction:
The Profitability Ratio is a major evaluation for understanding if organizations and companies are performing well. Considering this as a mandatory component, it is interesting to see that these theories are being practiced to avoid misinterpretations of sales and other aspects curating accurate results for the board of directors and owners. Here, profitability is the capacity through which a lot of money is earned.
Therefore, profitability technically refers to the leftover amount companies stash after reducing expenses and other costs accordingly. Quite interestingly, Profitability Ratio evaluates profit and compares companies to understand their financial standings. Ever since companies have started using this evaluation method for their profit account, various reforms have been made to acquire sharp results.
Different Profitability Ratios:
The different profitability ratios are as follows:
- Gross Profit Margin – GPM
- Return on Sales – ROS
- Return on Equity – ROE
- Return on Assets – ROA
- Return on Investments – ROI
- Operating Margin – OM
Example:
Since there are various certified ways to evaluate whether or not we get profit over our net sales, the easiest example is somewhat like this. Assume that ‘Micheal Clothing Store’ invested 100,000 to purchase the required inventory in one year.
Quite luckily, the owner sold the merchandise for 500,000 with an expected boom in the profit account. However, in a short span of time, 50,000 worth of inventory was sent back by the customers which is being refunded now.
According to this scenario, the owner of ‘Micheal Clothing Store’ use ‘Gross Margin Ratio’, which is derived from ‘Profitability Ratios’ to endure what his company lost and gained in a year.
.78 = 450,000 – 100,000/ 500,000 – 50,000
We’ve assumed the ratio of 78 percent as per the apparel market and the rest of the figures are mentioned in the example. The equation subtracts revenue through the cost of goods sold and the answer is divided by revenue again to achieve ‘Gross Profit Margin’.
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