Explore the key profitability ratios that measure a company's ability to generate income relative to its revenue, assets, operating costs, and equity, including gross margin ratio, return on assets ratio, and return on equity ratio.
Profitability ratios measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity.
- Gross Margin Ratio compares the gross profit of a company to its net sales to show how much profit a company makes after paying its cost of goods sold
Gross Margin Ratio = Gross Profit / Net Sales
What is a good gross profit margin ratio? On the face of it, a gross profit margin ratio of 50 to 70% would be considered healthy, and it would be for many types of businesses, like retailers, restaurants, manufacturers and other producers of goods.
- Return on assets ratio measures how efficiently a company is using its assets to generate profit
Return on Assets Ratio = Net Income / Total Assets
An ROA of 5% or better is typically considered good, while 20% or better is considered great. In general, the higher the ROA, the more efficient the company is at generating profits.
- Return on equity measures how efficiently a company is using its equity to generate profit.
Return on Equity Ratio = Net Income / Shareholder’s Equity
As with return on capital, a ROE is a measure of management's ability to generate income from the equity available to it. ROEs of 15–20% are generally considered good.