The main aim of an enterprise is to earn profit which is necessary for the survival and growth of the business enterprise. It is earned with the help of amount invested in business. It is necessary to know how much profit has been earned with the help of the amount invested in the business. This is possible through profitability ratios. These ratios examine the current operating performance and efficiency of the business concern. These ratios are helpful for the management to take remedial measures if there is a declining trend.
The important profitability ratios are:
- Gross Profit Ratio
- Net Profit Ratio
- Operating Profit Ratio
- Return on Investment Ratio
1. Gross Profit Ratio
It expresses the relationship of gross profit to revenue from operations (net sales). It is expressed in percentage.
Gross profit ratio shows the margin of profit. A high gross profit ratio is a great satisfaction to the management. It represents the low cost of revenue from operations. Higher the rate of gross profit, lower the cost of revenue from operations.
2. Net Profit Ratio
A ratio of net profit to revenue from operations (sales) is called Net profit ratio. It indicates sales margin on sales. This is expressed as a percentage. The main objective of calculating this ratio is to determine the overall profitability.
Net profit ratio determines overall efficiency of the business. It indicates the extent to which management has been effective in reducing the operational expenses. Higher the net profit ratio, better it is for the business.
3. Operating Profit Ratio
Operating profit is an indicator of operational efficiency. It reveals only overall efficiency. It establishes relationship between operating profit and revenue from operation (net sales). This ratio is expressed as a percentage.
It helps in examining the overall efficiency of the business. It measures profitability and soundness of the business. Higher the ratio, the better is the profitability of the business. This ratio is also helpful in controlling cash.