Profitability Ratios

FINA2201

What do Profitability Ratios measure?

Asses earnings component of free cash flow, specifically firm ability in controlling different expenses (direct production costs, operating expenses, nonoperating expenses).

What are the main profitability ratios?

Gross Margin, Operating Margin, EBIT Margin, Net Profit Margin.

Gross Margin

Gross Profit/Sales

What does a high Gross Margin indicate?

a company is generating a greater profit from sales; efficient management of costs and pricing.

Operating Margin

Operating Income/Sales

What does a high Operating Margin suggest?

A company generates a large portion of revenue as profit, and is profitable overall for investors.

EBIT Margin

EBIT/Sales

What does a high EBIT Margin suggest?

Firm is profitable — their Earnings Before Interest and Taxes (EBIT) aka pre-tax profit is converted in large quantities from sales revenue.

Net Profit Margin

Net Income/Sales

What does a high Net Profit Margin insinuate?

A firm is excellent at controlling its costs and/or providing goods and services at a price significantly above its costs. Net Income outweighs revenue.