Profitability ratios measures the income or operating success of a company for a given period of time. Income, or the lack of it, affects the company’s ability to obtain debt and equity financing. It also affects the company’s liquidity position and the company’s ability to grow. As a consequence, both creditors and investors are interested in evaluating earning power profitability. Analysts frequently use profitability as the ultimate test of management’s operating effectiveness.
Profitability is the net result of a large number of policies and decisions chosen by an organization’s management. Profitability ratios indicate how effectively the total firm is being managed. The profit margin for a firm is calculated by dividing net earnings by sales. There is wide variation among industries, but the average for U.S. firms is approximately 5 percent.
A profitability ratio is the measures of a company’s overall financial performance by evaluating its ability to generate revenues in excess of expenses.