Profitability Ratios

Profitability ratios measure a companies financial performance and its ability to increase its shareholders value and generate profits.  Profitability ratios provide insight into the profits made by the company in relation to its size, assets, and sales and also measure the companies performance in relation to itself.  Having past data as a benchmark, the firm can start to make conclusions as to why profitability is increasing or decreasing. 

There are four key measurements that can be used to slice and dice the profitability of a corporation; Profit margin ratios, return on assets, return on equity, and return on invested capital (ROIC) .  The return on assets formula and return on equity will allow us to understand the companies ability to generate profits from their asset pool or shareholder equity.  Profit margin ratios dissect the actual profit that a company generates on its sales and return on invested capital will measure profit in terms of the total capital used to generate those profits.

When calculating these ratios, be sure to exclude extraordinary items or discontinued operations as these items will distort the core profitability that these ratios are looking to measure.  Many of the components that these ratios are calculated with are found on the income statement or balance sheet of a company.
Tim Ord
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