Business

Profitability: How to Calculate and Improve the Indicator for Your Business 

There are many economic indicators that characterize the activities of an enterprise. One of these can be called the profitability of any business, including both a high-quality gambling platform PlayAmo and a recently-founded grocery store. What is it, what is this indicator used for and how to calculate it?

What Is Profitability

This is a relative economic indicator that characterizes the profitability of an enterprise. Besides the fact that profitability evaluates the effectiveness of the entire company, the indicator can also be calculated separately for each tangible or intangible asset: production materials, cash, labor, etc.

For a proper evaluation, the economic coefficient should be analyzed for different time intervals. If the production and sale of products bring the company a profit, the profitability of such an enterprise will be positive. When the efficiency ratio for an asset systematically decreases, urgent changes in the approach to doing business are required.

Why Calculate the Indicator

Profitability level is one of the important indicators of a company’s economic efficiency. It shows the company’s shareholders and future investors how well the business works and how quickly the financial investments in the investment project are paid back.

The calculation of profitability is necessary for:

  • Predicting a company’s future profits.
  • Comparing the company’s own economic efficiency with its competitors.
  • Identification of the market value of the company.
  • Developing a strategy for business development.
  • Determining the optimal pricing for the products produced.

Profit and profitability are not the same thing. Profit is an absolute indicator, expressed in numerical equivalent and showing the final financial result of business (the difference between the company’s revenue and its expenses). Profitability is a relative indicator expressed as a percentage and calculates a company’s profitability (the quotient of profit divided by expenses).

How to Calculate Profitability

Many resources (labor, financial, natural, production, etc.) are involved in the firm’s activities, and for each of them it is possible to calculate its economic efficiency separately, using different formulas of profitability. However, for a simplified understanding of the profitability of the company, you can use a universal calculation using the following formula:

P = Book profit / Total assets x 100%, where:

  • Balance sheet profit – profit (loss) before taxation received by the company from all of its business activities.
  • Total Assets – the total of all production capacities of the company and its resources (labor, money, etc.).

The Main Types and Formulas for Calculations

To evaluate the effectiveness of a business, economics uses different types of profitability. Let’s consider them.

ROA – Return on Assets

ROA (Return on Assets) is a coefficient showing the percentage ratio of net profit to assets.

ROA should be calculated in order to understand whether a company is making a profit or working at a loss over a long period of time. If the ROA is below zero, then the company is making a loss. Thus, the higher the ROA, the higher the economic efficiency of the company.

The formula for return on assets:

ROA = P / A, where:

  • P – net profit of the company;
  • A – the average value of total assets of the company.

When calculating ROA, the value of profit and total assets must be taken for the same time. For example, one year.

ROS – Return on Sales

ROS (Return on Sales) is an indicator that reflects the company’s share of profit in each ruble earned. The higher the value, the better the company works, the more profit it generates as a result of its activity.

The formula for return on sales:

ROS = Net Income / Revenue x 100%

ROS is an indicator of a company’s pricing policy. It should be used either for comparison with competitors in the industry, or to analyze the dynamics of the indicator within one company. It does not make sense to use ROS indicator for comparison of companies from different industries, as the coefficient does not take into account the specifics of each business.

ROE – Return on Equity

The ROE (Return on Equity) ratio shows the business owner and his investors how much net profit the company is able to bring in for each ruble invested in it. It is important to understand that the equity investment in this case refers only to the authorized or share capital.

The formula for calculating the return on equity:

ROE = Net Income / Equity × 100%

Equity is the equity or share capital of a company, equal to the difference between the total assets of the organization and its liabilities.

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