Profitability
Learn what profitability is, how to measure and calculate it, and practical ways to improve your margins.
June 2023 | Published by Xero
Published Thursday 23 July 2026
Table of contents
Key takeaways
- Profitability measures how efficiently your business turns expenses into profit, and it is most often shown as a profit margin.
- Profit is a dollar amount, while profitability is a ratio that shows how much of your revenue you keep as profit.
- You can measure profitability with gross profit margin, net profit margin, return on assets, and return on equity.
- Gross profit is revenue minus cost of goods sold, and net profit is revenue minus all business expenses.
What is profitability?
Profitability is a measure of how efficiently a business converts its expenses into profits for its owners, most commonly expressed as profit margin. In plain terms, it tells you how much of every dollar you earn ends up as profit.
A profitable business does more than bring in revenue. It keeps enough of that revenue after costs to reward the people who own and run it.
Profit vs profitability
Profit is an absolute dollar amount, while profitability is a relative measure of how efficiently you turn revenue into profit. The two are linked, but they answer different questions about your business.
Say your business earns 50,000 dollars in profit this year. That is your profit: a single dollar figure.
Now say a competitor also earns 50,000 dollars in profit, but they did it on half your revenue. Their profitability is higher, because they kept more of each dollar they earned.
How to measure profitability
You measure profitability with profitability ratios, which compare a type of profit to revenue, assets, or equity. The four ratios below give you a rounded view of how your business performs.
- Gross profit margin: the share of revenue left after the cost of goods sold, useful for judging pricing and production costs
- Net profit margin: the share of revenue left after all expenses, showing your overall bottom-line efficiency
- Return on assets: the profit you generate from every dollar of assets, showing how well you use what you own
- Return on equity: the profit you generate from the money owners have invested, showing the return to shareholders
Some businesses also track EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. It strips out financing and accounting effects to show operating performance, and it complements the return on investment view you get from the ratios above.
How to calculate profitability
The two margin ratios use figures straight from your income statement. Gross profit is revenue minus cost of goods sold, and net profit is revenue minus all business expenses.
You can calculate the two most common margins with these formulas:
- Gross profit margin = (gross profit / revenue) x 100
- Net profit margin = (net profit / revenue) x 100
Here is a short worked example. If your revenue is 100,000 dollars, your cost of goods sold is 40,000 dollars, and your other expenses are 35,000 dollars, your gross profit is 60,000 dollars and your net profit is 25,000 dollars.
That gives you a gross profit margin of 60% and a net profit margin of 25%. You can also review the math behind these ratios in this guide to profit margin.
What affects profitability
Several everyday factors push your profitability up or down, often at the same time. Keeping an eye on the ones below helps you spot what is squeezing your margins.
- Expenses: higher costs for materials, labour, or overhead reduce the profit left from each sale
- Demand: strong demand supports higher prices and volumes, while weak demand pressures both
- Productivity: getting more output from the same resources lifts the profit you keep
- Competition: rivals can force you to lower prices or spend more to win customers
Why profitability matters
Profitability shows whether your business can sustain itself and grow over time. A business can bring in plenty of revenue and still struggle if too little of it turns into profit.
Tracking profitability helps you price your work, control costs, and decide where to invest. It is one of the clearest signals of your business health.
How to improve profitability
Improving profitability usually comes down to earning more from each sale or spending less to make it. The practical actions below can help you lift your margins.
- Increase prices or change your fee structures
- Offer fewer price promotions
- Set marketing return on investment standards
- Find cheaper suppliers
- Buy supplies in bulk
- Develop more efficient workflows
- Track projects against budgets
- Submit change orders for out-of-scope work
- Automate processes
- Reduce costs
Track your profitability with Xero
Clear, up-to-date numbers make profitability much easier to measure and improve. With Xero, you can see your margins and financial reports in one place and act on them with confidence.
See how it fits your business and get one month free.
FAQs on profitability
Here are answers to some frequently asked questions about profitability to round out the details above.
What is the difference between profit and profitability?
Profit is the dollar amount you keep after costs, expressed as a single figure. Profitability rescales that figure against revenue, assets, or equity so you can compare efficiency over time or against other businesses.
What is a profitability ratio?
A profitability ratio compares a type of profit to another figure, such as revenue or assets, to show efficiency rather than raw dollars. Gross profit margin, net profit margin, return on assets, and return on equity are common examples.
How do you calculate profitability?
The quickest method is a margin: divide a profit figure by revenue and multiply by 100 to get a percentage. For a fuller picture, pair a margin with a return ratio such as return on assets.
What factors affect profitability?
Your expenses, customer demand, productivity, and competition all move profitability up or down. Small shifts in any one of them can change how much profit you keep from each sale.
Related terms
Learn more about profitability
Handy resources
Advisor directory
You can search for experts in our advisor directory
Income statement template
Download an income statement template to help track your profitability
Instant profitability reports
Generate key reports at the click of a mouse with Xero accounting software
Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.