Profitability ratios answer the most fundamental question any business owner — or CA examiner — will ask: is this business actually making money, and how efficiently? Before you analyse a company's liquidity or solvency, you first need to know whether it is profitable at all. That is the job of this ratio family.
The ICAI curriculum groups profitability ratios into two buckets. Margin-based ratios measure profit as a percentage of sales — they tell you how much of every rupee of revenue survives after paying costs. The three you must know cold are: Gross Profit (GP) Ratio = Gross Profit ÷ Net Sales × 100; Operating Profit Ratio = EBIT ÷ Net Sales × 100 (EBIT = Earnings Before Interest and Tax, i.e., operating profit); and Net Profit (NP) Ratio = Net Profit after Tax ÷ Net Sales × 100. A falling GP ratio but a stable NP ratio, for example, is a red flag — it usually means the company is cutting operating expenses to mask a deteriorating core business. Examiners love asking you to interpret this gap.
Return-based ratios measure profit against the money invested to generate it. The three pillars here are: Return on Capital Employed (ROCE) = EBIT ÷ Capital Employed × 100, where Capital Employed = Shareholders' Funds + Long-term Debt (or Total Assets − Current Liabilities); Return on Equity (ROE) = Net Profit after Tax − Preference Dividend ÷ Shareholders' Equity × 100; and Return on Assets (ROA) = Net Profit after Tax ÷ Average Total Assets × 100. ROCE is the most exam-tested return ratio — it measures how well management uses all long-term funds (debt + equity), not just equity, so it is a purer efficiency measure. If ROCE > cost of debt, the company is creating value for equity holders through financial leverage — a concept directly linked to the Financial and Operating Leverage chapter.
One nuance to handle carefully: Operating Profit excludes interest and tax (use EBIT), whereas Net Profit is after both. When a question gives you a P&L, reconstruct the numbers clearly before plugging into a formula. This is where most students drop marks — not from not knowing the formula, but from using the wrong profit figure. This topic appears frequently as a 4–8 mark question in Paper 6, either as a pure calculation or as a ratio interpretation/comparison case study.