## Profitability Ratios — Based on Sales
Profitability ratios measure the profitability / operational efficiency of the firm and reflect the final results of business operations. Management seeks to maximise these ratios to maximise firm value. They are broadly classified into four categories:
1. Based on Sales — Gross Profit, Net Profit, Operating Profit, Expenses ratios
2. Overall Return on Assets/Investments — ROI (ROA, ROCE, ROE)
3. Owner's point of view — EPS, DPS, Dividend Pay-out ratio
4. Market / Valuation / Investors — P/E ratio, Dividend & Earning Yield, MV/BV, Q ratio
This lesson covers the sales-based ratios.
### A. Gross Profit (G.P.) Ratio / Gross Profit Margin
Measures the percentage of each rupee of sale remaining after paying for the goods sold. It depends on the relationship between sales price, volume and costs. A high GP margin is a favourable sign of good management.
$$\text{Gross Profit Ratio} = \frac{\text{Gross Profit}}{\text{Sales}} \times 100$$
### B. Net Profit Ratio / Net Profit Margin
Measures the relationship between net profit and sales — the proportion of revenue that becomes profit after meeting all expenses. A high ratio indicates positive returns.
$$\text{Net Profit Ratio} = \frac{\text{Net Profit / EAT}}{\text{Sales}} \times 100 \qquad \text{Pre-tax Profit Ratio} = \frac{\text{EBT}}{\text{Sales}} \times 100$$
### C. Operating Profit Ratio
Evaluates operating performance — the percentage of each rupee of sale remaining after all costs and expenses except interest and taxes. Operating profit is often referred to as EBIT, and analysts follow this closely as it focuses on operating results.
$$\text{Operating Profit Ratio} = \frac{\text{Operating Profit (EBIT)}}{\text{Sales}} \times 100$$
where Operating Profit = Sales − COGS − Operating Expenses.
### D. Expenses Ratios
Expressed in several variants based on the concept of expense (all × 100 on Sales):
- COGS Ratio = COGS ÷ Sales
- Operating Expenses Ratio = (Admin OHs + Selling OHs) ÷ Sales
- Operating Ratio = (COGS + Operating Expenses) ÷ Sales
- Financial Expenses Ratio = Financial Expenses ÷ Sales
> Financial expenses exclude taxes, loss due to theft, goods destroyed by fire, etc.
Note: Administration Expenses Ratio and Selling & Distribution Expenses Ratio can be computed similarly.