Profitability Ratios evaluate the financial viability of a business and provide a measure of comparison and performance to the industry in which the business falls.
These ratios include:
NET MARGIN RATIO
The Net Margin Ratio measures how much a company earns after taxes relative to its sales. The formula is as follows:
Net Profit Margin = Net Profit/Revenue
A higher net profit margin tells the investor the business is more efficient and flexible and capable of taking on new opportunities.
OPERATING PROFIT MARGIN RATIO
The Operating Profit Margin Ratio measures earnings before interest and taxes (EBIT). The formula is as follows:
Operating Profit Margin = Operating Income/Net Sales
This gives the investor an idea of whether they want to invest in a company and bankers an idea of whether they should consider providing additional debt financing.
RETURN ON ASSETS RATIO
The Return on Assets Ratio measures how well management is using the company's resources. The formula is as follows:
Return on Assets = Net Income/Total Assets
This will vary widely by industry but it gives investors an idea of how well the company is leveraging its assets to benefit the investment return.
RETURN ON EQUITY RATIO
The Return on Equity Ratio measures how well the business as an investment is doing relative to the investment by its shareholders. The formula is as follows:
Return on Equity = Net Income/Shareholder's Equity
This helps investors understand how much money the company is earning for each invested dollar and may be a good predictor of return for their investment.
While these formulas are straightforward, I have created a spreadsheet calculator for readers to use an explore. If you're interested, you can download the Efficiency Ratio Calculator using the button below. If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.
A few notes on this calculator:
- This calculator is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture and its unique financial statements.
- This calculator is only an example to give the reader an idea of how such a tool can be developed. The numbers within are not based on a real business. I compiled this as an offshoot of work in a graduate class, but I have created developed similar models for entrepreneurial ventures. Each business venture is different, and so is the ratios used and considered for that enterprise.
- Financial Ratio calculations are done annually using actual numbers. This model can be used in that way. It can also be used to calculate and review ratios monthly. Monthly numbers would allow the reader to track improvements over time.
- All of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
- By downloading you acknowledge this is for personal use only. It is not to be sold or distributed in any way.
Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.
David Harkins is a business strategist, speaker, and teacher.
He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.
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