Essential Business Formulas - Profitability Ratios
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If your business isn’t profitable, it won’t be around for long if you don’t start making changes. The profitability ratios help you to analyze where problems are occurring that make your business unprofitable. It is essential that every business owner understand how to use profitability ratios. Profit margins are some of the simplest margins to compute. Information for most of these formulas is found on your income statement.
Gross Profit Margin
Gross profit, or the profit after subtracting the cost of sales, shows you how much money you have to operate your business. The gross profit margin gives you the percentage of your revenue that remains after the cost of your sales. You should compare this margin to the industry standard to be certain that you are not spending too much on your sales.
Formula: Gross Profit Margin: [Gross Profit / Sales]
Operating Profit Margin
The operating profit is very similar to the gross profit, but it measures the amount of money that remains after you have paid your sales expenses and your operating expenses. This is also known as the earnings before taxes and interest (EBIT).
Formula: Operating Profit Margin: [Operating Income / Sales]
Net Profit Margin
Net profit, or the bottom line, is the money remaining after you have paid all expenses. If you are a business owner, this is the money left for you. For larger companies, this money is either invested back into the company or paid out in dividends. You can set goals for your net profit margin or compare it to industry standards, but the margin itself will not indicate the cause of the problem; rather, it will tell you that there is a problem.
Formula: Net Profit Margin: [Net Profit / Sales]
Return on Assets
This formula measures how effectively your business uses its assets to create revenue.
Formula: Return on Assets: [Net Income / Total Assets]
Return on Equity
The last commonly used profitability ratio is the return on equity, also known as the return on investment (ROI). This measures how much money you have earned on your investment.
Formula: Return on Equity: [Net Income / Owner’s Equity]
Business Plan Success automatically calculates the most common business ratios & formulas for analysis in your business plan.
Find out more about how Business Plan Success can create your business plan financial statements.
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