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Profitability: one of the most important company metrics

In our article, we will address the question of what profitability is and what the key figure is used for. In addition, we explain important terms and explain how you can calculate profitability using different forms.

What is Profitability?

Profitability is an important one identification number. The profitability is usually given as percentage and thus as a ratio. Profitability becomes that achieved by a company Profit in relation to the capital employed set.

In practice, profitability is an important metric when measuring and analyzing the success of a company. Profitability is calculated using a general and simple formula, which is:

(Earnings before interest / tied capital) * 100

Thus, profitability indicates the relationship between the profit achieved and the capital employed.

 

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Difference between profitability, productivity and profitability

When it comes to profitability, experts often speak of profitability and productivity. However, the three terms are not synonymous.

The productivity simply means that a company carries out its business activities and is productive. However, this does not mean that the company is profitable. The term economics Above all, mean that there will be no losses, at least not in the long term. Even in this case, however, profitability is not necessarily a given.

What is profitability used for?

The key figure of profitability is used by analysts in particular to determine the financial success, so the profit of a company too evaluate. In the context of the following three variants of profitability differentiated:

  • Return on investment
  • Return on equity
  • Return on sales

Based on the ratio of profit to capital employed, the profitability indicator can be used to assess how successful a company is in the market.

What is the Profitability Forecast?

While analysts determine profitability based on current numbers and data, the profitability forecast is about an outlook for the future. As a rule, such a preview extends to a period of three financial years.

In order for a profitability forecast to be created, the following questions must be answered:

  • How much money does the company have to generate to finance ongoing expenses?
  • How much money does the company have to invest in projects?
  • What is the future turnover that will be generated within the next three years?

Important terms related to profitability

Profit & Profit Margin

When it comes to profitability, there are a few important terms that are often used in context. These are, for example, profit and profit margin.

Put simply, profit is the difference between the effort and the result achieved by a company. In other words: the Profit consists of the Difference between all income and expenses or costs of a company.

The Profit margin becomes common Return on sales called. It is a measure that says something about which one Share of profit in sales (in percent) Has. The higher the profit margin, the more profit the company will make.

What is liquidity?

With the liquidity, the Solvency of a company designated. Experts measure these primarily by whether the company is able to meet its obligations. This includes the following payments in particular:

  • Employee salaries
  • Rent and utilities
  • Paying outstanding invoices

It is very important for a company to always have sufficient liquidity. If this were not the case, the worst case scenario could be bankruptcy.

Conflicting goals: liquidity and profitability

There is a certain trade-off between liquidity and profitability. The reason is liquid funds almost always with one low yield are connected. For example, if companies have liquidity available in the form of credit balances on a call money account, only low interest is credited for it. Therefore, companies should try to strike a good balance between sufficient liquidity and profitability on capital.

In addition to profitability, it is important to understand other technical terms that are often associated with the key figure. These include in particular liquidity, profit and also sales.

How can I calculate profitability?

There are several forms of what kind of profitability can be calculated. First and foremost, you need two pieces of information for the calculation, namely

  • on the one hand the profit
  • and on the other hand, the capital employed.

Which values ​​you need in detail depends on the type of profitability to be calculated.

Return on equity

When looking at return on equity, you only look at a company's equity. Using the formula, you can determine the percentage by which the equity capital was reduced or increased. To do this, you use the following formula for the so-called return on equity:

Return on equity = annual result / equity * 100

Return on debt

The return on debt is not about increasing the company's assets; instead, it determines the average amount of debt costs (interest) that the company has to pay for borrowed capital. The formula for calculating the return on debt is:

Return on debt = debt interest / debt * 100

Return on investment

With the total return on capital, you consider the entire capital employed by the company, i.e. both equity and debt. You put this in relation to all asset increases, consequently to the annual result and the interest on borrowed capital. The corresponding formula is:

Return on total capital = (annual result + interest on borrowed capital) / total capital * 100

Return on sales

Another key figure is the return on sales. This shows you which part of the generated sales can ultimately be booked as profit. The so-called return on sales formula is:

Return on sales = profit / sales

ROE formula

ROE is short for "Return on Equity" (return on equity). It is therefore a question of return on equity, which we briefly explained earlier.

What is the Profitability Comparison Calculation?

With the so-called profitability comparison calculation, you compare the returns of different investments. The goal is to identify the investment that is likely to offer the best return.

What profitability is good is relative. Average rates apply, depending on the market situation Returns between four to six percent mostly as good values.

How can I improve profitability?

There are a number of ways you can improve business profitability. The following table shows you which options exist and which respective examples occur in practice.

measureexample
reduce costsReduce material expenses, agree on a discount
increase salesMake offers, accept new products
Correct pricing and billing policyCompare prices with the competitions and possibly adjust the price
Optimize internal organizationStructure and distribute tasks more efficiently internally
Check pricing strategyAnalysis of whether a price increase would be accepted by customers
Use cooperationsReduce purchase prices
Cost-conscious use of energyReduce energy consumption

What alternatives are there as a key figure?

In addition to profitability, there are other key figures with which experts can alternatively or additionally carry out an analysis of the economic situation of a company. These include the following groups of metrics:

  • Performance indicators, for example profit before taxes
  • Key figures on the capital structure (balance sheet figures), for example equity ratio
  • Liquidity ratios, for example cash ratio
  • Debt ratios, for example debt servicing ability

Conclusion

The profitability is a key figure with which you can use the Measure the success of a company can. The larger the percentage, the more profitable the company is.

In today's economy, almost all companies and businesses aim to be as profitable as possible. Just like that growth and in the further course the consolidation and expansion of the Market position possible.

 

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