Profitability Ratios In Business

Profitability ratios

Profitability ratio is to measure the success of the company in earning profit from its operating activity. Business generally exist with the primary purpose of creating wealth for their owners. This ratio provides some indication of the degree of success in achieving this purpose. Common profitability ratios used in analysing a company's performance include Return on equity (ROE), Return on capital employed (ROCE), Gross profit Margin, Net profit margin, Expenses ratio. Return on equity (ROE)

Return on equity ratio is a measure of profitability that calculates how many profit a company generates with each dollar of shareholders' equity. This ratio compares the amount of the profit for the period available to owners with

A business will be concerned with amount of funds tied up in debtors and try to keep this to a minimum. The speed of payment can have a significant effect on the business’s cash flow.

Formula: ( Average Debtors)/(Credit Sales) x365days

Debtors turnover

Debtors turnover is to assess the liquidity of the receivable. It measures the number of times, on average, the company collects receivables during the period. The debtors turnover ratio is an activity ratio measuring how efficiently a firm uses its assets. This ratio shows how efficient a company is at collecting its credit sales from customers.

Formula: ( Credit Sales)/(Average Debtors)

Stock holding period

The stock holding period measure the average period for which stocks are being held. Stocks often represent a significant investment for a business. Holding stock for longer periods than necessary may indicate that the business has money tied up unnecessarily in inventory.

Formula: ( Average Stock)/(Cost Of Sales)

When calculating dividend coverage for ordinary share capital, it is necessary to deduct any dividend paid on irredeemable preference shares from the net profit earned during the accounting period. This ratio is used by investors to estimate the risk of not receiving dividends.

Formula: ( Earnings)/(Ordinary Dividend)

Price/Earning ratio (P/E)

The price/earning ratio is an oft-quoted measure of the ratio of the market price of each share of common stock to the earnings per share. This ratio reflects investors’ assessments of a company’s future earnings. It indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings.

Formula: ( Market value per Share )/(Earning Per Share)

Price/Book ratio

The price/book ratio is a ratio used to compare a stock's market value to its book value. This ratio reflects the value that market participants attach to a company's equity relative to its book value of equity. The price/book ratio indicates whether or not a company's asset value is comparable to the market price of its stock.

Formula: (Market value per Share)/(Book value Per Share)