PROFITABILITY RATIOS

Question 1

What do Profitability Ratios measure?

Answer 1

Profitability Ratios measure a company’s ability to generate profit.

Question 2

Gross Profit Margin

Gross Profit Margin =

Answer 2

Gross Profit / Revenue x 100

Gross Profit Margin = Gross Profit / Revenue x 100

Shows the percentage of revenue left after covering the cost of goods sold.

Good if: Higher percentage.
Industry-dependent, but a margin above 50% is strong for product-heavy businesses.

Question 3

Net Profit Margin

Net Profit Margin =

Answer 3

Net Income / Revenue x 100

Net Profit Margin = Net Income / Revenue x 100

Indicates how much of every dollar of revenue is translated into profit.

Good if: Higher percentage.
A strong margin typically exceeds 10% for many industries but varies widely. For tech companies, 20–30% might be considered good.

Question 4

Return on Assets (ROA):

ROA =

Answer 4

Net Income / Total Assets x 100

ROA = Net Income / Total Assets x 100

Measures how efficiently a company uses its assets to generate profit.

Good if: Higher percentage.
A strong ROA is usually above 5%. Capital-intensive industries may see lower ROA values, while asset-light businesses may achieve higher values.

Question 5

Return on Equity

ROE =

Answer 5

Net Income / Total Assets x 100

ROE = Net Income / Shareholder’s Equity x 100

Measures how efficiently a company uses its assets to generate profit.

Reflects how effectively a company uses shareholders’ investments to generate earnings.

Good if: Higher percentage.
A strong ROE exceeds 15%. A low ROE may indicate inefficient use of equity.

Question 6

What are the 4 General Profitability Ratios

Answer 6

Gross Profit Margin
Net Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)