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What Is Net Profitability Ratio: Definition & Types Of Profitability Ratios

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When an investor looks into a company’s profile, one of the first things he wants to know about is the net profit ratio of the company. The net profit ratio is one of the metrics that help the investors in understanding the profitability of the company against its revenues, cost of operations, taxes, etc. If you have the net profit ratio of different companies, you can use the data to compare their performance on the basis of profitability. By using the net profit ratio formula, you can easily find the net profit of the company. The net profit ratio formula is as follows: Net Profit/ Total Revenue x 100.

Let us understand this with the help of an example. If the net profit of a company is Rs 40,000 and its total revenue is Rs 4,00,000, then according to the net profit ratio formula, the net profit ratio margin would be 40,000/4,00,000 x 100 = 10%.

Types of Profitability Ratio

There are different types of profitability ratios. Some of them are as follows: 

Return on Equity Ratio 

The return on equity ratio is highly useful to the investors to figure out how much profit they are making from their investment. In this ratio, they can find out the percentage of their income on the equities invested. By using this ratio, shareholders can evaluate, if they should continue investing in a particular company or not. 

Dividend Per Share Ratio

The shares show the amount of dividend that is to be distributed among the shareholders. A company having a high dividend per share ratio indicates that they are able to generate higher surplus money in comparison to other companies. 

Price Earnings Ratio

To understand and analyze the price of both the undervalued and overvalued shares, the price-earnings ratio can be put to use. In other words, this profitability ratio is used to compare the current market price of a share with the earnings it generates. 

Returns on Capital Employed 

This profitability ratio is ideally used by the company’s owner to find out the profit margin the company is making for the investments made in it. It shows how much return the company is being able to make in comparison to the money invested in it. 

Return on Assets

Return On Assets is also known as ROA and is a profitability ratio used to calculate the net earnings of a company against its total assets. It is important to the companies’ investors as ROA gives them an idea of how efficiently the company is able to use the assets to generate profit. 

There are many other profitability ratios that investors and owners of a company can use to their advantage to figure out valuable analyses of the profit the company is making. 

Advantages of Using Net Profit Ratio

There are several advantages of using the net profit ratio. Let us take a look at some of them: 

  • It is a tool through the help of which we can find out about the net profitability of a company.
  • We can use the net profit ratio formula to figure out the net profit margin of different companies and compare their reports. 
  • If a company has a high net profit ratio, it suggests that it is able to manage its cost of operations and productions effectively and at the same time still manage to sell products at a higher price. 
  • As the value of the net profit ratio is figured out in percentage, this can help us in finding out how much profit can be made in a single penny. 

As it turns out, the net profit ratio can be utilized in a different manner by investors to the owners of the company. But it is important to take the fact into consideration, that this profitability ratio alone should not be the parameter to evaluate a company from an overall perspective. 

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