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Profitability ratio is used to evaluate the company’s ability to generate income as compared to its expenses and other cost associated with the generation of income during a particular period. This ratio represents the final result of the company.

Let’s understand in detail about Profitability ratio:

## 1. Importance

Profitability represents final performance of company i.e. how profitable company. It also represents how profitable owner’s funds have been utilized in the company.

## 2. Types of Profitability Ratio

I. Return on Equity

II. Earnings Per Share

III. Dividend Per Share

IV. Price Earnings Ratio

V. Return on Capital Employed

VI. Return on Assets

VII. Gross Profit

VIII. Net Profit

### I. Return on Equity

This ratio measures Profitability of equity fund invested the company.  It also measures how profitably owner’s funds have been utilized to generate company’s revenues. A high ratio represents better the company is.

Formula: Profit after Tax ÷ Net worth

Where,

Net worth = Equity share capital, and Reserve and Surplus

### II. Earnings Per Share

This ratio measures profitability from the point of view of the ordinary shareholder. A high ratio represents better the company is.

Formula: Net Profit ÷ Total no of shares outstanding

### III. Dividend Per Share

This ratio measures the amount of dividend distributed by the company to its shareholders. The high ratio represents that the company is having surplus cash.

Formula: Amount Distributed to Shareholders ÷ No of Shares outstanding

### IV. Price Earnings Ratio

This ratio is used by the investor to check the undervalued and overvalued share price of the company. This ratio also indicates Expectation about the earning of the company and payback period to the investors.

Formula: Market Price of Share ÷ Earnings per share

### V. Return on Capital Employed

This ratio computes percentage return in the company on the funds invested in the business by its owners. A high ratio represents better the company is.

Formula: Net Operating Profit ÷ Capital Employed × 100

Capital Employed = Equity share capital, Reserve and Surplus, Debentures                                               and long-term Loans

Capital Employed = Total Assets – Current Liability

### VI. Return on Assets

This ratio measures the earning per rupee of assets invested in the company. A high ratio represents better the company is.

Formula: Net Profit ÷ Total Assets

### VII. Gross Profit

This ratio measures the marginal profit of the company. This ratio is also used to measure the segment revenue. A high ratio represents the greater profit margin and it’s good for the company.

Formula: Gross Profit ÷ Sales × 100

Gross Profit= Sales + Closing Stock – op stock – Purchases – Direct Expenses

### VIII. Net Profit

This ratio measures the overall profitability of company considering all direct as well as indirect cost. A high ratio represents a positive return in the company and better the company is.

Formula: Net Profit ÷ Sales × 100

Net Profit = Gross Profit + Indirect Income – Indirect Expenses

Example:

 Particulars Amount Shareholder Equity Equity Shares, 2346 share outstanding, Par value 0.05 118 Paid In Capital 5858 Retained Earning 13826 Total Shareholder Equity 19802 Total Assets 30011 Current Liability 8035 Total Sales 53553 Gross Profit 16147 Net Operating Profit 3028.65 Net Profit 3044

Profitability Ratios:

1)            Return on Equity = Profit After tax / Net worth,

= 3044/19802

=  15.37%

2)            Earnings Per share = Net Profit / Total no of shares outstanding

= 3044/2346

= 1.30

3)            Return on Capital Employed = Net Operating Profit / Capital                                                                                                   Employed * 100

=3028.65/(30011-8035)*100

= 13.78%

4)            Return on Assets = Net Profit / Total Assets

= 3044/30011

= 10.14%

5)            Gross Profit = Gross Profit / sales * 100

= 16147/53553*100

= 30.15%

6)            Net Profit = Net Profit / Sales*100

= 3044/53553*100

= 5.68%