Understanding profitability ratios helps you measure your business's ability to generate profit and make smarter financial decisions.
Profitability ratios measure how effectively your business generates profit relative to revenue, assets, or equity. Key ratios include gross profit margin (revenue minus cost of goods sold), net profit margin (net income ÷ revenue), return on assets (net income ÷ total assets), and return on equity (net income ÷ owner's equity). Higher ratios indicate better profitability. Lenders and investors use these ratios to assess business performance and financial health.
Measures profit after direct costs (cost of goods sold) but before operating expenses.
Gross Profit Margin = (Revenue - COGS) ÷ Revenue × 100
Example: $100k revenue, $60k COGS = 40% gross margin
Learn more about profit margin formula.
Measures profit after all expenses (the bottom line). Most comprehensive profitability measure.
Net Profit Margin = Net Income ÷ Revenue × 100
Example: $100k revenue, $15k net income = 15% net margin
Use our net income calculator to calculate.
Measures how efficiently assets generate profit. Higher ROA means better asset utilization.
ROA = Net Income ÷ Total Assets × 100
Example: $50k net income, $500k assets = 10% ROA
Measures return on owner's investment. Important for investors and business owners.
ROE = Net Income ÷ Owner's Equity × 100
Example: $50k net income, $200k equity = 25% ROE
Profitability ratios tell you:
Profitability ratios vary by industry. Here are typical ranges:
Grow sales through marketing, new products, or expanding to new markets. Higher revenue improves all profitability ratios.
Negotiate better supplier terms, improve production efficiency, or find lower-cost materials. Lower COGS improves gross margin.
Cut unnecessary costs, automate processes, or renegotiate contracts. Lower expenses improve net margin.
Use assets more efficiently or sell underutilized assets. Better asset utilization improves ROA.
If you have pricing power, increase prices to improve margins. Test price increases carefully to avoid losing customers.
It depends on your industry. Generally, 10-20% net profit margin is considered good for most small businesses. Service businesses often have higher margins (20-30%), while retail and restaurants have lower margins (3-7%). Compare to industry benchmarks.
Both matter. Gross margin shows pricing power and cost control. Net margin shows overall profitability after all expenses. Lenders focus more on net margin because it reflects your ability to generate profit and repay loans.
Lenders check profitability ratios to assess your ability to generate profit and repay loans. Higher ratios improve approval chances and get better rates. Low or negative margins are red flags. Learn about how to qualify for business loans.
Extremely high margins (50%+ net) can indicate pricing too high (risking customer loss) or underinvestment in growth. However, high margins are generally positive and show strong business performance.
Detailed guide to calculating profit margins.
Calculate your net income and profit margins.
Learn about liquidity ratios alongside profitability ratios.
Compare your profitability ratios to industry benchmarks.
Our team can help you understand your financial ratios and find financing to support growth and improve profitability.
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