Financial Metrics - Profitability Ratios
Does your average markup on goods normally cover expenses, and therefore result in a profit? Gross Profit on Net Sales will tell you. If your gross profit rate is continually lower than your average margin, something is wrong! Be on the lookout for downward trends in your gross profit rate. This is a sign of future problems for your bottom line.
Closely linked with income ratios are profitability ratios, which shed light upon the effectiveness of management regarding returns generated on sales and investment. The following is the formula:
(Net Sales - Cost of Goods Sold) / Net Sales = Gross Profit on Net Sales Ratio
This percentage can vary greatly from business to business including in the same industry. Sales location, size of operations, and intensity of competition are all factors that can affect the gross profit rate.
Profitability ratio will gauge the effectiveness of management in profits from the sales. With intense competition, it is essential to optimize the profitability of every sale. Brian Halla states, “It's one thing to put this business on the books. It's far more important to maximize the profit from it.”