Question

There are many types of ratios that financial analysts use to estimate the health of a company. One important type focuses on measuring how well a company is actually performing. These are known as "profitability" or "performance" ratios. We can get a sense of whether or not a company is being efficient in its use of assets. It looks at questions such as: Does the company generate a reasonable amount of sales for the assets held? Are its profits reasonable for the amount of sales it generates or assets held?

Answer 1

Profitability ratios gives some yardstick to measure the profit in relative terms with reference to sales, assets or capital employed. These ratios highlight the end result of business activities. The main objective is to judge the efficiency of the business. A measure of 'profitability' is the overall measure of efficiency. In general terms, efficiency of business is measured by the input-output analysis. By measuring the output as a proportion of the input, and comparing result of similar other firms or periods the relative change in its profitability can be established.

Profitability ratios can be determined on the basis of either investments or sales. Profitability in relation to investments is measured by return in capital employed, return on shareholders' funds and return on assets. The profitability in relation to sales are gross profit margin ratio, net profit margin ratio, expense ratio or operating ratio.