Profitability Ratios

Gross Profit Ratio This ratio demonstrates how well the business is efficiently producing or providing products and services. It shows how well products are priced given the direct or variable costs it takes to create or provide them. The better the ratio, the higher the profit potential.
  • Gross profit:    What is gross profit?
  • Sales:    What are sales?
    Interpret Your Results
  • The bigger the better - bigger means the business is making more in gross profit per dollar earned then it is costing to directly earn that dollar - example, it takes $5 to make and distribute a product that the business charges $12 for. Thus, the business makes $7 in gross profit or a 58.33 gross profit percentage.
  • You can either compare this number to industry averages, other similar companies or even to your past or historical results as you want to see this number trending upward.
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  • Click Here - to see possible ways to improve this ratio
  • Gross Profit
    Ratio:

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Pretax Profit Ratio This ratio demonstrates how efficiently the business is operating overall - showing that expenses (specifically operating or overhead or fixed expenses) are not disproportionate - meaning that the business does not have more expenses than it needs to properly operate the business in generating profits.
  • Pretax Profit:    What is pretax profit?
  • Sales:    What are sales?
    Interpret Your Results
  • The higher the percentage, the more the business has to cover taxes, investor returns or for net profits.
  • A high number shows that the business does not have excessive expenses meaning that it is efficiently generating revenue or operating in a profitable manner; that it does not have too much overhead given current level of sales.
  • You can either compare this number to industry averages, other similar companies or even to your past or historical results as you want to see this number trending upward.
  •  
  • Click Here - to see possible ways to improve this ratio
  • Pretax Profit
    Ratio:

    %
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Ways to Improve: Gross Profit Ratio: Two ways to improve the Gross Profit Ratio. 1) Increase prices of goods or services provided. However, make sure that your prices remain competitive - thus see what prices your competitors are charging or find ways to make and market products with premium features to competitors thus justifying the higher price. 2) Find ways to lower your direct or variable costs - this could be by reducing factory expenses (making more with less effort), reducing direct labor (get less people to do more) or find lower cost materials that go into your goods or services - to name a few. The idea here is to generate either the same or more revenue per product or service while reducing the costs of producing or providing those products and services. Gross profit is what the business will then use to cover overhead, operating expense, taxes and profits, thus if the business is not making enough here, it cannot make it up elsewhere. Items to consider in improving this ratio:
  • Poor purchasing efforts - not getting the materials needed at advantageous pricing (like bulk buying).
  • Poor inventory control - buying to much materials and realizing additional costs like spoilage or obsolescence.
  • Poor product mix - spending more time and effort (expenses) on lower margin products.
- Back to Gross Profit Ratio -

Pretax Profit Ratio: Provided the business is earning as much as it can in gross profit, improving this ratio would require finding ways to reduce overhead or operating expenses. This could be done by:
  • Reducing fixed expenses related to property, plant and equipment including rent/lease expenses, utilities, maintenance, etc - without hurting production or operations.
  • Reducing marketing and sales expenses (getting better marketing and sales results with lower expenses - efficiency).
  • Reducing General and Administrative expenses related to non-direct wages and salaries and salary expenses, supplies, accounting, bad debt, entertainment, insurance or any non-direct expenses - non-directly related to creating or providing products and services.
- Back to Pretax Profit Ratio -

Other financial ratio calculations you may want to evaluate:

Disclaimer: These ratios are for education purposes only and are in no way an adequate substitute for a professional financial advisor.

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Financial Ratios - Profitability