Profitability ratios measure the company’s success in revenues and profits by assessing the quality, quantity and timing of profits generated relative to the assets, investments, and equity of the company. As such, the purpose of profitability ratios is to measure how efficiently a company is using its resources to generate income and ultimately enhance shareholder value. Among the most commonly utilized profitability ratios are the return on assets, return on equity and gross profit margin.

Return on assets (ROA) is a profitability ratio that measures how efficiently a company is using its assets to generate profits. It is calculated as net income over total assets (Net Income / Total Assets). A higher return means that the company is more efficient in utilizing its assets to generate profits, so it is a useful measure of comparing the efficiency of different companies.

Return on equity (ROE) is another profitability ratio that measures the return generated on a company’s shareholders’ investments. It is calculated as net income over shareholders’ equity (Net Income / Shareholders’ Equity). Companies that generate higher ROE results are more successful in generating returns on the shareholders’ investments.

Gross Profit Margin is also a profitability ratio that measures how efficiently a company is generating profits from its sales. It is calculated as gross profit over revenue (Gross Profit / Revenue). All other things being equal, companies that generate higher gross profits with their sales are considered to be better managed and more profitable.

Gross Profit Margin, Return on Assets, and Return on Equity are just three of the many different profitability measures that are used to measure a company’s financial performance. Other profitability measures include operating margin, net profit margin, asset turnover, and debt/equity ratio. These ratios should all be measured in comparison to a similar industry average, the company’s own historical performance, or to results from comparable companies in order to gain a clear picture of a company’s ability to generate value and profits for its shareholders.

In a fast-moving and ever-changing business environment, assessing a company’s profitability is a key factor in making sound investment decisions. Profitability ratios provide managers and investors with valuable indicators of a company’s efficiency and prospects for financial success. Investors and analysts should always consider a company’s profitability when evaluating its potential.