Profitability ratio and its classification
What do you understand by the term profitability ratio?
Definition: This is the gauge for measuring financial performance of an organization. It is a tool that provides the bigger picture of the efficiency expected by the management and the owners of the business as pertains profit making of the organization.
You see, your objective as an entrepreneur is to make profits, then it means you need to invest in an asset, which is income generating. The asset may be of fixed (ie non-current) or current nature.
Your concern will then be to compare the returns/profits gotten in monetary terms with the capital outlay incurred or paid to purchase the asset associated with the income generation. This means we can have a mainstream profitability ratio expressed as;
Where;
Operating profit refers to Earnings before Interest and Taxation (ie EBIT)
Capital Employed represents manifold capital issues as it will be discussed
NB1: That capital employed means many things for there are various ways of utilizing capital. This will be demonstrated in the classification of profitability ratios as stated below
Profitability ratio is broadly classified in to three perspectives, namely;
- Return on Investment
- Return on Equity
- Return on Assets
