The profitability ratio of the firm can be measured by calculating various profitability ratios. General two groups of profitability ratios are calculated.
Profitability in relation to sales
1. GROSS PROFIT MARGIN OR RATIO
It measures the relationship between gross profit and sales. It is calculated by dividing gross profit by sales.
2. NET PROFIT MARGIN OR RATIO
It measures the relationship between net profit and sales of a firm. It indicates management’s efficiency in manufacturing, administrating, and selling the products. It is calculated by dividing net profit after tax by sales.
Net profit margin or ratio = Earning after tax X 100 / Net Sales
3. OPERATING PROFIT MARGIN OR RATIO
It establishes the relationship between total operating expenses and net sales. It is calculated by dividing operating expenses by the net sales.
Operating expenses includes cost of goods produced/sold, general and administrative expenses, selling and distributive expenses.
4. EXPENSES RATIO
While some of the expenses may be increasing and other may be declining to know the behavior of specific items of expenses the ratio of each individual operating expenses to net sales should be calculated. The various variants of expenses are
5. OPERATING PROFIT MARGIN OR RATIO