What are Profitability Ratios? Types & Formulas (2025)
Table of Contents
Profitability ratios are financial metrics used to assess a business’s ability to generate profit from its revenue.
These ratios are a cornerstone of profitability analysis—used by investors, analysts, and internal decision-makers to evaluate financial health, benchmark performance against competitors, and spot trends over time.
They’re typically grouped into margin ratios and return ratios—and together, they paint a full picture of your business performance.
In this guide, we’ll walk you through key ratios, what they mean, and formulas on calculating them. Let’s dive in.
Quick Recap:
- Profitability ratios are financial metrics used to assess a business’s ability to generate profit from its revenue.
- These ratios are a cornerstone of profitability analysis—used by investors, analysts, and internal decision-makers to benchmark performance.
- Profitability ratios fall into two main categories: margin ratios and return ratios. The higher profitability ratios, the better. But consider if it fits your business model and supports your long-term growth.
What are Profitability Ratios?
Profitability ratios are financial metrics used to assess a business’s ability to generate profit from its revenue. Instead of focusing solely on how much money a business brings in, these ratios zero in on what’s left after all the costs—materials, labor, operating expenses, interest, and taxes—have been paid.
What is the Purpose of Profitability Ratios?
Profitability ratios are used to evaluate a business’s ability to generate profit over time in relation to its revenue, costs, assets, or equity. These ratios are a cornerstone of profitability analysis—used by investors, analysts, and internal decision-makers to evaluate financial health, benchmark performance against competitors, and spot trends over time.
By comparing profits to different parts of the business (like sales, total assets, or equity), profitability ratios give a clearer picture of where a company is strong or where it might be underperforming.
Further Reading
What are the Types of Profitability Ratios?
Profitability ratios fall into two main categories: margin ratios and return ratios.
Margin ratios measure how much profit your business keeps from its revenue. It shows the percentage of your revenue is left after deducting specific types of expenses—whether that’s the cost of goods sold (COGS), operating costs, or all expenses combined.
The three core margin ratios include:
- Gross profit margin
- Operating profit margin
- Net profit margin
Return ratios evaluate how effectively a company uses its assets or equity to generate profit. It shows the relationship between net income (or net profit) and the resources used to produce it, such as:
- Total assets
- Shareholders’ equity
- Invested capital
Further Reading
How to Calculate Profitability Ratios?
Let’s break down the formulas for both margin and return ratios.
Margin Ratios Formula
Gross profit margin is a business performance metric that measures the percentage of revenue that exceeds the cost of goods sold (COGS). It’s a core health indicator for product profitability analysis. To calculate it using this formula:
Operating profit margin is a profitability ratio that shows what percentage of revenue remains after paying for core operating expenses—but before interest and taxes. It’s often used to evaluate how well a company controls its core costs and how scalable its operations are.
The formula is:
Further Reading
Net profit margin is the percentage of revenue left after all business expenses are deducted. That includes COGS and operating expenses, interest, taxes, and any one-time charges. It’s considered the most comprehensive indicator of overall profitability because it reflects everything that impacts your bottom line.
It is calculated as:
Further Reading
Return Ratios Formula
Return on Assets (ROA) measures how efficiently a business uses its total assets to generate net income. ROA is calculated by dividing net income by total assets.
Return on Equity (ROE) measures a company’s ability to generate profit using shareholders’ capital. It's the percentage of profit earned for each dollar of equity held by shareholders.
The formula for ROE is:
Finally, Return on Invested Capital (ROIC) compares operating profit (after tax) to all the money invested in the business, giving a clear picture of how well the business is performing.
The formula is:
What are Good Profitability Ratios for Business?
Here’s a breakdown of what’s considered “good” profitability:
Profitability Ratios Benchmark
- A good gross margin typically falls between 20% and 50%, depending on the type of business.
- A good operating margin usually ranges from 10% to 20%, though this varies.
- A healthy net margin is often 10% or higher, though for some sectors like retail or food & beverage, even 5% is acceptable.
- A ROA of 5% or more is typically considered good.
- Investors usually look for ROE in the 15%–20% range or higher.
- A ROIC above 10% is a strong sign, especially if it consistently exceeds the company’s cost of capital.
Further Reading
As a rule of thumb: The higher, the better. But context is everything. A “good” profitability ratio isn’t just about hitting a number—it’s about being profitable in a way that fits your business model and supports your long-term growth.
Further Reading
What are Limitations of Profitability Ratios
However, these ratios have significant limitations because they don’t reveal the causes behind profitability trends.
A high net profit margin, for instance, might suggest strong performance—but it won’t tell you whether the improvement came from increased sales, cost-cutting, or a one-time event like selling an asset. On the flip side, a drop in profitability could result from rising raw material costs, declining sales, or inefficiencies in operations—but the ratio alone won’t clarify which.
Understanding profitability ratios is a great first step—but applying them consistently is what drives real growth.
If you’re a Shopify seller, TrueProfit can make this process effortless. It automatically tracks your net profit, real-time margins, and key financial ratios—even as your COGS, ad spend, or shipping fees fluctuate. So instead of guessing where your business stands, you’ll always have a clear, up-to-date picture of your performance.
Profitability Ratios FAQs
Is asset turnover a profitability ratio?
No, asset turnover is not a profitability ratio. It’s an efficiency ratio that measures how effectively a company uses its assets to generate revenue.
Is return on assets (ROA) a profitability ratio?
Yes, ROA is a profitability ratio. It shows how well a company uses its assets to generate net income.
Is current ratio a profitability ratio?
No, the current ratio is a liquidity ratio. It measures a company’s ability to pay short-term liabilities using its short-term assets.
Is debt to equity ratio a profitability ratio?
No, debt to equity is a solvency ratio. It evaluates a company’s financial leverage by comparing total debt to shareholders’ equity.
Is earnings per share (EPS) a profitability ratio?
Not exactly. EPS is considered an earnings indicator, but not a pure profitability ratio. It measures the portion of a company’s profit allocated to each outstanding share of common stock.
Is net profit margin a profitability ratio?
Yes, net profit margin is a key profitability ratio. It shows the percentage of revenue that remains as net income after all expenses.
Is return on equity (ROE) a profitability ratio?
Yes, ROE is a profitability ratio. It measures how efficiently a company uses shareholders’ equity to generate profit.
Is ROA a profitability ratio?
Yes, ROA (Return on Assets) is a profitability ratio that shows how efficiently a company turns its assets into net income.
Is ROE a profitability ratio?
Yes, ROE (Return on Equity) is a profitability ratio that reflects how effectively a company generates profit from shareholders’ investments.
What are the five profitability ratios?
The five most common profitability ratios are:
- Gross profit margin – shows how efficiently a company produces goods.
- Operating profit margin – measures profit after operating expenses.
- Net profit margin – reflects the percentage of revenue left after all expenses.
- Return on assets (ROA) – indicates how effectively assets generate profit.
- Return on equity (ROE) – shows how well equity is used to create earnings.
What are the 7 types of ratio analysis?
Ratio analysis typically covers these seven types:
- Profitability ratios
- Liquidity ratios
- Solvency ratios (or leverage ratios)
- Efficiency ratios (or activity ratios)
- Market valuation ratios
- Coverage ratios
- Operating ratios
Each offers different insights into a company’s financial health.
What is the probability ratio?
There is no standard financial metric called the “probability ratio.” It may be a mistaken reference to profitability ratio, which evaluates a company’s ability to generate profit. If the context is about risk or forecasting, “probability” might relate more to statistical or predictive modeling rather than financial ratios.
What are the 5 ratios of financial analysis?
Five commonly used ratios in financial analysis include:
- Profitability ratios – measure earnings vs. expenses.
- Liquidity ratios – assess short-term financial health.
- Solvency ratios – evaluate long-term debt sustainability.
- Efficiency ratios – analyze how well assets are managed.
- Market ratios – help investors value a company’s shares.
What are the 5 Ps of profitability?
The “5 Ps of profitability” is a strategic business framework that includes:
- Product – Is it desirable and scalable?
- Price – Is it set to optimize margin and demand?
- Place – Where and how is the product sold?
- Promotion – Are marketing efforts converting profitably?
- People – Are the team and operations driving efficiency?
This model helps businesses identify key areas to boost profitability.
What is the EBITDA margin?
EBITDA margin stands for Earnings Before Interest, Taxes, Depreciation, and Amortization as a percentage of total revenue. It measures a company’s core profitability before non-operational expenses. A higher EBITDA margin often signals strong operating efficiency.
What are the 5 basic ratio classifications?
The five basic classifications of financial ratios are:
- Profitability ratios
- Liquidity ratios
- Solvency ratios
- Efficiency ratios
- Valuation or market ratios
Each category provides a different lens on a business’s financial performance.
What are the 6 financial ratios that analyze financial statements?
Six key financial ratios commonly used to analyze financial statements include:
- Gross profit margin
- Net profit margin
- Current ratio
- Debt-to-equity ratio
- Inventory turnover ratio
- Return on equity (ROE)
Together, they help evaluate profitability, liquidity, efficiency, and financial risk.
What are 4 ratio classifications?
Four primary financial ratio classifications are:
- Profitability – Measures earning power.
- Liquidity – Assesses ability to meet short-term obligations.
- Solvency (Leverage) – Examines long-term financial stability.
- Efficiency (Activity) – Evaluates how effectively resources are used.
Is ROCE a profitability ratio?
Yes, ROCE (Return on Capital Employed) is considered a profitability ratio. It measures how efficiently a company uses its capital to generate profits. It’s especially useful for comparing profitability across capital-intensive businesses.
Harry Chu is the Founder of TrueProfit, a net profit tracking solution designed to help Shopify merchants gain real-time insights into their actual profits. With 11+ years of experience in eCommerce and technology, his expertise in profit analytics, cost tracking, and data-driven decision-making has made him a trusted voice for thousands of Shopify merchants.
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