Question

What value do profitability ratios bring to stakeholders? What are some of the ratios included in that category?

Answer 1

Profitability ratios tell about the profitability of operations of the company. By using the profitability ratios, stakeholders come to know about the success or failure of the company for a given time period. It shows how a company has utilized its assets to produce or generate income in relation to revenue and other costs. Some common profitability ratios are:

(a) Gross margin ratio = Gross Margin / Sales

This ratio measures how profitable a company sells its merchandise.

(b) Net Profit margin ratio = Net income / Sales

This ratio indicates profit rate earned.

(c) Return on assets ratio = Net income / Average total assetsThis ratio indicates the rate of earnings in relation to its assets. It shows how well a company is utilizing its assets in earning income.

(d) Return on equity = Net income / Average equity

This ratio indicates how well a company is utilizing its investments or capital contributed by equity stockholders.