Question

Briefly describe the ratios that can be used to evaluate a company’s profitability.

Short answer

A company can use theprofitability ratiosto evaluate its profitability.

Step-by-step solution

Meaning of Profitability Ratio

The profitability ratios are the ratios that determine a company's power to produce revenue concerning its outlays and other expenses incurred in income production during a specific timeframe. This ratio can determine the company's ultimate performance.

Explanations of various profitability ratios

• Return on Equity

This ratio evaluates the profitability of the equity fund that the corporation has invested in the business. The higher the ratio, the better it is.

$Return on equity=\frac{\mathbf{ProfitafterTax}}{\mathbf{Networth}}$

• Earnings per Share

This ratio calculates the amount each shareholder can earn on the company's net income according to the number of shares they have. A higher proportion indicates a better company.

$Earning per share=\frac{\mathbf{NetProfit}}{\mathbf{Totalno}\mathbf{.}\mathbf{ofsharesoutstanding}}$

• Return on Capital Employed

This ratio calculates the percentage of the money a business earns by how efficiently using the capital invested in the company. A higher ratio is considered better.

$Return on capital employed=\frac{\mathbf{NetOperatingProfit}}{Capital employed}\mathbf{\times }\mathbf{100}$

• Return on Assets

This ratio calculates the rate of return a company earns by using the company's assets efficiently. A high ratio indicates that a company is doing better.

$Return on Assets=\frac{\mathbf{NetProfit}}{Total Assets}$

• Gross Profit

This ratio calculates the percentage of profit a company earns on its selling price. A high ratio helps the corporation since it indicates a higher profit margin.

$Gross profit ratio=\frac{\mathbf{GrossProfit}}{\mathbf{Sales}}\mathbf{\times }\mathbf{100}$