You can evaluate the effectiveness of any commercial company by calculating profitability indicators. This is a fairly large group of coefficients that characterize the ratio of profit to expenses, revenue or any resources. It does not make much sense to consider all possible calculation options here, so we will focus on the most important ones.
Product profitability reflects how much profit will bring each unit invested in the cost of goods, products or services. Already from the definition it becomes clear how to determine the profitability of products. To do this, it is necessary to divide profit by cost. Using different profits in the calculations will allow you to get different indicators, but most often, profitability is determined by net profit.
Obviously, it is impossible to draw the right conclusions by calculating only the profitability of the product. The return on assets, sales and equity is also determined.
The rate of return on assets is determined by the ratio of profit to the total assets of the enterprise. The meaning of this indicator is very clear: it shows how many units of profit the company brings each unit invested in the formation of assets.
More capacious is the rate of return on sales. It can be calculated using either the sales profit or the net profit in the numerator, and the denominator in any case will be revenue. In the first option, the indicator allows you to judge the pricing policy of the enterprise, as well as the effectiveness of cost management. The second option, in addition to this, also takes into account the impact of the tax factor. In the General case, the ratio in question characterizes the share in the revenue.
If we calculate the ratio between the net profit received and the amount of the organization’s own capital, then we get the value of the profitability ratio, obviously, of the equity. The meaning of this indicator is very important, since determining the effectiveness of the use of owners' capital allows us to judge the organization’s ability to generate income, and also makes it possible to compare with alternative options for investing money.
A simple calculation of profitability indicators, most likely, will not be enough to formulate conclusions. It is necessary to evaluate the change in these indicators over several years in order to judge the positive or negative dynamics. In addition, it is worth comparing various indicators of profitability among themselves.
More important than determining the dynamics of indicators can only be identifying the causes of certain changes. To judge what exactly and to what extent influenced the profitability ratios is possible by applying factor analysis. Most often, factor analysis is carried out in relation to the return on equity and assets using the DuPont methodology.
Through simple transformations, it can be found that the return on assets is affected by their turnover and return on sales, and in the case of equity, a financial dependency ratio is added to these factors. Using the method of absolute differences , the influence of each of these factors is determined separately, as well as their influence in the aggregate.
As you can see, with all its simplicity, indicators such as product profitability and other profitability ratios play an extremely important role in describing the financial condition of a company. Each of them is associated with the most important indicator of efficiency - profit, therefore, their calculation should be given special attention.