How is profitability measured?

Today, we experience the word ‘revenue’ and ‘profit’ being used interchangeably to denote income generated from the sale of goods and services. Revenue is defined as income generated from selling goods and services while profit is the residual income after taking into consideration expenses. In this part of the world, we see entities generating revenue and incurring losses at the end of the reporting period. Therefore, generating revenue does not denote making profit automatically.

 

One of the reasons why an entity may record revenue, and still end up with a loss is as a result of the entity incurring significant operating cost.  As entities seek to maximize revenue, so also, they must seek to minimize cost in other to generate significant profit.

 

So, how is profitability measured? In practice, there are ratios that measure the profitability of an entity. Some of the ratios are:

 

1.    Gross Profit Margin (GPM): This is a profitability ratio that measure the amount of revenue after taking into consideration Cost of sales. GPM is usually expressed as a percentage.

 

2.  Operating Profit Margin (OPM): OPM measures the percentage of revenue relative to operating cost.

 

3.  Net Profit Margin (NPM): NPM measures the percentage of profit relative to revenue generated.

 

4.    Return on Capital Employed (ROCE): ROCE measures the percentage of revenue generated from the amount of capital used.

 

5.    Return on Asset (ROA): ROA measures the percentage of a company’s asset being used in generating revenue.

 

6.  Return on Equity (ROE): ROE measures the percentage of profit generated relative to shareholders investments.

 

The higher the percentage of any of the ratios above, the higher the profitability of the entity, do you agree? 

Today I have know the difference between revenue and profit.

I totally agree with you. It's imperative that as professionals we constantly look for ways to add value to our organization. A further analysis of profit using the ratios you stated is one of the valid ways.