Calculating Profitability Ratios: Types, Benefits and Examples

Profit, profit, or profit may not be a foreign term that you often find in the financial process of a business. Well, in addition to the terms profit, profit, or profit, it turns out that there is one term that has almost the same meaning among the three, namely the profitability ratio.

Usually the term profitability ratio is used in accounting, maybe for those of you who are new to the world of finance, you are not too familiar with the term profitability ratio.

However, don't worry because DailySocial will share a summary of the profitability ratios. Come on, find out more about the profitability ratio right now!

What is a profitability ratio?

Quoted from the investopedia page, the profitability ratio is a financial metric measure used to assess the ability of a business to generate income relative to operating fund activities, asset balance sheets, shareholder equity over time using data from a specified period.

Profitability ratios are also usually used by financial analysts and investors as evaluation material, because investors will usually look for companies that have high ratios. For with a high profit, cash flow, or the income of a company means that its financial performance is also going well.

Understanding profitability ratios according to experts

Experts or experts also have specific definitions for profitability ratios, including:

Susan Irawati (2006)

Profit ratio or profitability ratios is the ratio used to measure the efficiency of the use of company assets or is the ability of a company to generate profits for a certain period (usually semiannual, quarterly and others) to see the company's ability to operate efficiently.

Agus Sartono (2010)

Profitability ratio is the company's ability to earn profits in relation to sales, total assets and own capital.

Cashmere (2011)

Profitability ratio is a ratio to assess the company's ability to seek profit.

Profitability ratio benefits

After knowing the definition of the profitability ratio, then you are also obliged to know what are the benefits and functions of the profitability ratio other than as an evaluation material for investors.

1. As a material for evaluating companies related to finance from time to time, to see the development of company profits.
2. Used by investors as material for company valuation.
3. To find out how much profit or profit earned by the company in a certain period.
4. It can also be a form of financial comparison, especially the income statement with the previous period.
5. To find out how much net profit after deducting taxes and capital.
6. As a material to assess the productivity of the company through the management of funds for capital.
7. As a measure to find out gross profit on net sales.
8. Measuring net income generated from total assets and equity funds.
9. Become a benchmark in the assessment that will be carried out by the bank on the company.
10. Become a benchmark of assessment for stock traders, to see whether your company's shares are worth buying or not.

Types of profitability ratios and how to calculate them

There are various types of profitability ratios and of course each type also has a different formula for profitability ratios. The following are the types of profitability ratios in corporate finance:

1. Return on Asset Ratio

Return on assets ratio or return on assets ratio is a profitability ratio to assess the percentage of profit generated by the company related to total assets in order to be efficient. A company that can manage its assets well can be seen from the ratio of return on assets.

Asset return ratio formula:

ROA = Net Profit : Total Assets

For example, a company has a net profit of Rp. 150 million with total assets of Rp. 50 million. So, this company's ROA is:

ROA = 150 million : 50 million = 3%

2. Sales Return Ratio

Sales return ratio or return on sales ratio is a profitability ratio that shows the company's profit after deducting labor wages, raw materials, before deducting interest or taxes.

 The formula for the return on sales ratio or ROS is:

ROS = (Profit before tax and interest : Sales) x 100%

An example of calculating ROS is as follows:

PT ABC generated a profit before tax of IDR 200 million on sales of IDR 2 billion.

ROS = (Rp200 million : Rp2 billion) x 100% = 0,1%

3. Net profit margin

Margin net profit or also net profit margin is the profitability ratio used to calculate the percentage of net profit before deducting taxes to income earned from sales. Net profit margin is also sometimes referred to as profit margin ratio.

To count net profit margin  are as follows:

Net Profit Margin = Net profit after tax : Sales

Example for calculating net profit margin:

Net profit after tax is Rp750 million with net sales income is Rp980 million.

Net profit margin = IDR 750 million : IDR 980 million = 0,76%

4. Gross Profit Margin

In addition to net profit margin, gross profit margin or gross profit margin also included in the profitability ratio used to calculate the percentage of gross profit to revenue that has been generated from sales.

The formula for calculating gross profit margin:

Gross profit margin = (gross profit: total revenue) x 100%

Example:

ABC Company's gross profit was IDR 56 million with total revenue of IDR 78 million. So gross profit margin these companies are:

Gross profit margin = (Rp56 million : Rp78 million) x 100% = 71%

5. Return on Equity Ratio

Return on Equity Ratio (ROE) is a profitability ratio in assessing the company's ability to generate returns from shareholder investments made in the form of a percentage.

Return on equity ratio formula:

ROE = Net profit after tax : Shareholders' equity

An example of calculating the return on equity ratio:

Based on the December 2021 financial statements, PT ABC has a net profit after tax of IDR 700 million with total shareholder equity of IDR 900 million. Then the return on equity ratio is as follows:

ROE = IDR 700 million : IDR 900 million = 77,7%

6. Return on Capital Used

Return on capital used or return on capital employment (ROCE) is a profitability ratio that is useful for assessing the company's profit from the capital used in the form of percent.

There are two types of return on capital formulas, namely:

ROCE = Profit before tax and interest : Working Capital

ROCE = Profit before tax and interest : (Total assets - Liabilities)

7. Earnings Per Share (EPS)

Earning per share is a type of profitability ratio used to assess the level of ability per share in generating profits for the company you manage, EPS is also used as an indicator of the success of a company.

The EPS formula is as follows:

EPS = (Net income after tax - Preferred Stock Dividend) : Number of ordinary shares outstanding

8. Return on Investment (ROI)

ROI or return on investment is a type of profitability ratio which is calculated from net income after deducting taxes to total asset funds. The higher the ROI of a company, the better its financial condition.

The ROI formula is as follows:

ROI = ((Return on investment - initial investment) : Investment) x 100%

An example of calculating ROI, a company invests Rp. 500 million and gets sales of 500 units. Then, from the sale, the company made a profit of Rp. 650 million. It is also known that the investment profit is Rp. 150 million and the initial investment capital is Rp. 500 million.

ROI = ((Rp650 million - Rp500 million): Rp500 million) x 100 = 30%

ROI obtained is 30%.

Well, those are the benefits, types, formulas, and examples of calculating profitability ratios. To monitor the profitability ratio you can also use for mobile devices to report the accountancy online.