# Profitability Ratios Based on Sales
Profitability ratios based on sales measure how much profit a firm earns from each rupee of sales. They are the first window into operating efficiency because they tie earnings directly to revenue.
## The Four Sales-Based Profitability Ratios
### 1. Gross Profit Ratio
$$\text{Gross Profit Ratio} = \frac{\text{Gross Profit}}{\text{Net Sales}} \times 100$$
- Gross Profit = Net Sales − Cost of Goods Sold
- Expressed in percentage
- Indicates the margin available after meeting direct manufacturing/trading costs.
### 2. Operating Profit Ratio
$$\text{Operating Profit Ratio} = \frac{\text{Operating Profit}}{\text{Net Sales}} \times 100$$
Operating Profit is derived as:
| Step | Item |
|---|---|
| Start | Net Profit as per P&L Account |
| Add | Non-Operating Expenses (loss on sale of assets, preliminary expenses w/o, etc.) |
| Less | Non-Operating Income (rent received, interest, dividend received) |
| = | Operating Profit |
Significance: Indicator of operating performance of the business. It strips out one-off or non-core items.
### 3. Net Profit Ratio
$$\text{Net Profit Ratio} = \frac{\text{Net Profit}}{\text{Net Sales}} \times 100$$
- Net Profit is taken from P&L A/c — either before tax (PBT) or after tax (PAT) depending on the data and question.
- Always state clearly which version you have used.
### 4. Contribution Sales Ratio (P/V Ratio)
$$\text{P/V Ratio} = \frac{\text{Contribution}}{\text{Sales}}$$
Where Contribution = Sales − Variable Costs. This links profitability with cost behaviour (variable vs fixed).
## Putting It Together — Profitability Funnel
Think of sales-based profitability as a top-down funnel:
Sales → (less COGS) → Gross Profit → (less operating expenses) → Operating Profit → (less interest & tax) → Net Profit
Each ratio examines a different stage of this funnel.