Profitability ratios: types, formulas and examples

Published Thursday 2 April 2026

Table of contents

• What are profitability ratios?
• What do profitability ratios measure?
• Types of profitability ratios
• Gross profit margin
• Net profit margin
• Return on assets
• FAQs on profitability ratios

Key takeaways

• Calculate your gross profit margin regularly to ensure you keep enough from each sale to cover operating expenses like rent, utilities, and marketing before reaching net profit.
• Track your net profit margin monthly or quarterly to measure how efficiently you turn sales into actual profits, as higher margins make you less reliant on high sales volumes.
• Use return on assets (ROA) to evaluate whether expensive investments like equipment or property generate sufficient profit, especially before making major purchases.
• Compare your profitability ratios to industry benchmarks and monitor trends over time rather than focusing on absolute numbers, as good ratios vary significantly by industry and business model.

What are profitability ratios?

Profitability ratios are financial metrics that show how well your business turns revenue, assets, or investments into profit. They help you measure whether your business is earning enough to cover costs and generate returns.

These ratios can give you a clear picture of financial health beyond just looking at your bank balance, but a lack of standardisation can be a challenge. A Chartered Financial Analyst (CFA) Institute survey found a majority of investors expect standard setters to define key subtotals like operating profit. By tracking them regularly, you can spot trends, compare performance over time, and make informed decisions about pricing, spending, and growth.

For small businesses, profitability ratios answer a simple question: is your business actually making money, and how efficiently?

What do profitability ratios measure?

Profitability ratios measure how efficiently your business converts spending into profit. They reveal the relationship between your costs and the money you keep.

Different ratios focus on different types of spending. Not all of them will be relevant to every small business, so choose the ones that match your operations and goals.

Types of profitability ratios

Profitability ratios fall into two main categories, each focusing on a different type of spending. Understanding the difference helps you choose which ratios to track.

Margin ratios

Margin ratios focus on your day-to-day spending, also called operating expenses. They show what percentage of revenue your business keeps after covering costs. Certain metrics are highly valued by external stakeholders; a CFA Institute survey found nearly 70% of investors use earnings before interest, taxes, depreciation, and amortisation (EBITDA) in their analysis.

The two main margin ratios are:

• gross profit margin: measures profit after paying for goods or services sold
• net profit margin: measures profit after paying all expenses

Return ratios

Return ratios focus on expensive investments like equipment, property, or major projects. They're most relevant to growing businesses, as they measure the return on expensive initiatives.

The two main return ratios are:

• return on assets (ROA): measures how well your assets generate profit
• return on invested capital (ROIC): measures the return on new investments

Gross profit margin

Gross profit margin shows what percentage of revenue remains after paying for the goods or services you sell. This is also called your cost of goods sold (COGS).

Your gross margin needs to be large enough to cover general expenses like rent, utilities, marketing, insurance, and administration. What's left after those costs is your net profit.

Why it matters

* Net profit can be quoted before or after taxes. If quoting after-tax net profit then you need to also subtract taxes.

A higher gross margin means you keep more of each sale. This gives you more room to cover operating costs and still turn a net profit.

Monitoring your gross margin helps you spot threats to sustainability early. It also reveals opportunities to improve performance through pricing changes or cost reductions.

Formula for calculating gross profit margin ratio

Use this formula to calculate your gross profit margin as a percentage.

For example, if your revenue is €100,000 and your cost of goods sold is €60,000, your gross profit margin is 40%.

Learn more in the guide on how to measure profitability.

* We use value of assets rather than 'average value of assets' because the latter is for businesses that are buying and selling assets all the time... which doesn't reflect a small business.

Get tips to improve these ratios in the guide on how to increase profit.

Net profit margin

Net profit margin shows what percentage of revenue remains after paying all expenses. This is the portion of each sale you actually keep.

You can pay this money to owners as drawings or dividends, or reinvest it in growth.

Why it matters

A higher net profit margin means you're efficient at turning sales into profits. Higher margins make you less reliant on big sales figures, which helps small businesses that can't compete on volume alone. This focus on tailored performance metrics reflects a larger trend, with the proportion of Standard & Poor's (S&P) 500 companies reporting a Non-Generally Accepted Accounting Principles (GAAP) key performance indicator (KPI) increasing from 65% in 2013 to 85% in 2022.

Finding the right margin involves trade-offs:

• lower prices: may increase sales volume and drive total profits higher
• higher marketing spend: may bring in more customers while keeping prices steady
• higher staff investment: may improve operations and customer experience

It's a delicate balance. Track your margins over time to find what works for your business.

* Net profit can be quoted before or after taxes. If quoting after-tax net profit then you need to also subtract taxes.

Formula for calculating net profit margin ratio

Use this formula to calculate your net profit margin as a percentage.

For example, if your revenue is €100,000 and your total expenses are €80,000, your net profit margin is 20%.

Return on assets

Return on assets (ROA) measures how efficiently your assets generate profit. Assets include property, equipment, vehicles, and intellectual property.

ROA is most relevant if you've invested heavily in expensive equipment, real estate, or other major assets. For service businesses with few physical assets, this ratio may be less useful.

Why it matters

ROA tests whether your assets are working hard enough. A high ratio suggests you're getting good value from your investments, but comparing can be complex since methods for calculating inputs like profit vary widely. One International Accounting Standards Board (IASB) study found that companies used at least nine different ways to calculate operating profit. A low ratio may indicate you've overinvested in certain areas or your assets are underperforming.

Use ROA to evaluate major purchases before you make them, and to assess existing assets you might sell or replace.

* Value of assets is used rather than 'average value of assets' because the latter is for businesses that are buying and selling assets all the time...

Formula for calculating return on assets ratio

Use this formula to calculate your return on assets as a percentage.

For example, if your net profit is €20,000 and your total assets are €100,000, your ROA is 20%.

FAQs on profitability ratios

Here are answers to common questions about profitability ratios.

What's a good profitability ratio?

A good profitability ratio depends on your industry and business model. Compare your ratios to industry benchmarks and track them over time to identify trends and opportunities for improvement.

How often should I calculate profitability ratios?

Calculate your profitability ratios monthly or quarterly to track performance trends. Regular monitoring helps you identify issues early and make timely adjustments to your business strategy.

Which profitability ratio is most important?

The most important ratio depends on your business goals. For most small businesses, net profit margin is crucial as it shows overall profitability. If you've made significant asset investments, ROA becomes equally important.