Profit Ratios Every Investor Should Know: Accounting is the language of business, and profit ratios are one of the most important tools investors have to understand how a company is performing.
By comparing a company’s profit ratios to its industry peers, investors can get a good idea of how well the company is managing its costs, generating revenue, and creating shareholder value.
Financial ratios are calculations that use quantitative data from a company’s financial statements. They are used to evaluate the overall financial condition of a company or organization.Â
Financial ratios can be used to compare a company’s financial status or production against other firms. They can also be used to make forecasts related to the future possibilities for growth and expansion.
By understanding these ratios, investors can make smarter investment decisions by getting insights into a company’s ability to generate profits.
Some of the most important profit ratios include return on equity (ROE), return on assets (ROA), net profit margin, and gross profit margin.
Read: Top 20 MS Excel Features that can be helpful in Financial Modeling
Here are 14 of the most important profit ratios for investors:
- Gross margin measures how much profit a company makes on its sales after paying for the cost of goods sold. A high gross margin indicates that a company is efficient in its production and/or has a strong pricing power.
- EBITDA margin measures a company’s profitability before interest, taxes, depreciation, and amortization (EBITDA). This ratio is a good measure of a company’s operating efficiency and can be used to compare companies across different industries.
- Operating margin measures a company’s profitability after paying for all operating expenses, including cost of goods sold, selling, general, and administrative expenses. This ratio is a good measure of a company’s ability to control its operating costs.
- EBIT margin measures a company’s profitability before interest and taxes. This ratio is a good measure of a company’s ability to generate profits from its operations, regardless of its financing structure.
- EBT margin measures a company’s profitability before taxes. This ratio is a good measure of a company’s ability to generate profits after paying for all operating expenses and interest expenses.
- Net profit margin measures a company’s profitability after paying for all operating expenses, interest expenses, and taxes. This is the most basic measure of a company’s profitability.
- Free cash flow margin measures a company’s ability to generate cash flow from its operations after paying for all operating expenses, interest expenses, and taxes. This ratio is a good measure of a company’s ability to generate cash flow that can be used to invest in growth or return to shareholders.
- Earnings per share (EPS) measures how much money a company makes for each share outstanding. This is a key metric for investors because it shows how much profit each shareholder is entitled to.
- Return on assets (ROA) measures how much profit a company generates from its total assets. This ratio is a good measure of a company’s overall profitability.
- Return on equity (ROE) measures how profitable a company is in relation to its equity (the money shareholders have invested in the business). This ratio is a good measure of how well a company is using its shareholders’ money.
- Return on invested capital (ROIC) shows you how efficiently a company is allocating capital. This ratio is a good measure of how well a company is using its assets to generate profits.
- Return on capital employed (ROCE) measures the profitability of a company and the efficiency with which it uses its capital. This ratio is similar to ROIC, but it focuses on the long-term debt and equity of a company.
- Free cash flow conversion measures how much earnings are translated into free cash flow. This ratio is a good measure of how well a company is managing its cash flow.
- Owner’s earnings measures how much cash can be taken out of the business and given to owners. This ratio is a good measure of how much cash is available to shareholders.
These are just a few of the most important profit ratios for investors. By understanding these ratios, investors can get a better understanding of how a company is performing and make more informed investment decisions.
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