Profitability
Learn what profitability means, how to measure it with key ratios and how to improve your business margins.
June 2023 | Published by Xero
Published Wednesday 30 September 2026
Table of contents
Key takeaways
- Profitability shows how efficiently your business turns revenue into profit, expressed as the percentage of each sale you keep
- Gross, net and operating profit margins, return on assets and return on equity each show a different layer of your financial health
- What counts as a good margin depends on your industry, so compare your results with sector benchmarks and your past performance to set realistic targets
- You can lift profitability by reviewing prices, cutting unneeded costs, keeping customers and checking your margins every month or quarter
What is profitability?
Profitability measures how efficiently your business turns revenue into profit, shown as a percentage of sales. Profit is a ringgit amount, while profitability tells you how much of each sale you keep.
The most common measure is your net profit margin, which you work out with this formula:
- Profitability = (net profit ÷ revenue) × 100
Say your business earns RM500,000 in revenue and keeps RM75,000 as net profit. Your profitability is 15%, so you keep 15 sen from every ringgit of sales after covering all your costs.
Profit vs profitability
Profit is the ringgit amount your business keeps after expenses, while profitability is the share of revenue that becomes profit. You need both to judge how your business is performing.
Here’s how two businesses compare:
- Business A earns RM2 million in revenue and keeps RM100,000 in profit, a 5% margin
- Business B earns RM400,000 in revenue and keeps RM80,000 in profit, a 20% margin
Business A makes more profit in ringgit, but Business B is four times as profitable. Business B keeps 20 sen of every ringgit it earns, while Business A keeps 5 sen.
When you plan for growth, aim to grow total profit while holding your margin.
Profitability vs cash flow
Profitability measures what your business earns over a period, while cash flow tracks the actual money moving in and out of your bank account. A business can show a healthy profit on paper and still run short of cash.
The gap usually comes down to timing. Say you finish a RM50,000 job in March and invoice it straight away. It counts towards your March profit, but if the client pays in May, you still need cash for April’s wages and rent.
Other common gaps between profit and cash include:
- stock you’ve paid for but haven’t sold yet
- loan repayments, where only the interest counts as an expense
- equipment you pay for upfront but spread over several years as depreciation
- customer invoices that are overdue or paid in instalments
Why profitability matters
Profitability shows whether your business model can last. A profitable business can reinvest in growth and build a cash buffer for quieter months.
Tracking profitability regularly helps you:
- see how much revenue you need to reach your profit goals
- make better decisions about pricing and hiring, based on what’s driving your returns
- show lenders and investors the ratios they check before approving finance
- spot early warning signs, such as margins shrinking while revenue stays flat
So what’s a good margin? Brex says that, as a rule of thumb, a 5% net margin is low, 10% is healthy and 20% is high.
Your industry makes a big difference. NYU Stern’s January 2026 margin data puts the average net margin for US publicly traded companies at 9.74% across the total market. General retail averages 5.61%, grocery and food retail 1.32%, and system and application software 25.49%.
These are US listed-company averages, so Malaysian small business margins may differ. Use them as a rough guide alongside your own past results.
Factors that affect profitability
Profitability depends on what you charge and what it costs you to deliver, and you can influence most of the factors below.
Pricing strategy
Your prices set the upper limit on your margins. Price too low and you struggle to cover costs; price too high and you lose sales. Review your pricing strategy regularly so it reflects your costs and the value you deliver.
Cost of goods sold
Cost of goods sold (COGS) is the direct cost of producing or buying what you sell. It’s often your biggest cost, so better supplier terms or bulk buying can lift your gross profit margin.
Operating expenses
Operating expenses are the running costs of your business, such as rent, utilities, insurance, marketing and admin. Review your overheads regularly to find costs you can reduce without affecting quality.
Interest on business loans also reduces net profit, so the more you borrow, the more sales you need to cover it.
Customer demand and sales volume
Higher sales volume can improve profitability when your fixed costs stay fairly stable. Heavy discounting to chase volume can wear down your margins, so check that extra sales add to your bottom line.
Competition
Competitive pressure can push you to lower prices or spend more on marketing. Standing out through better service or a specialist offer helps protect your margins.
Productivity and efficiency
The more efficiently your team works, the more output you get for each ringgit spent on wages. Staff training and software that automates repetitive tasks both help.
Scale
As your business grows, economies of scale can spread fixed costs across more revenue. Growth also brings new costs, such as extra staff, so track whether scaling up improves your margins.
How to measure profitability
You measure profitability with profitability ratios, and each one shows a different part of your financial performance. The figures you need are on your profit and loss statement and balance sheet.
Follow these steps to measure your profitability:
- Pull your latest financial statements for the period you want to review
- Choose the ratio that answers your question, such as gross profit margin for pricing
- Work out the ratio using the formulas below
- Compare the result with previous periods and industry figures
Your accounting method affects the results. Accrual accounting records income and expenses when they’re earned or incurred, while cash accounting records them when money changes hands. Compare periods using the same method.
Gross profit margin
Gross profit margin shows the percentage of revenue left after you subtract COGS. It tells you how efficiently you produce or source what you sell.
- Gross profit margin = ((revenue minus COGS) ÷ revenue) × 100
Say your revenue is RM300,000 and your COGS is RM180,000. Your gross profit is RM120,000, so your gross profit margin is (RM120,000 ÷ RM300,000) × 100 = 40%. A margin calculator can do the maths for you.
Net profit margin
Net profit margin shows the percentage of revenue left after you pay all expenses, including COGS, operating costs, interest and tax. It’s the fullest view of your profitability.
- Net profit margin = (net profit ÷ revenue) × 100
Using the same RM300,000 of revenue, say your total expenses come to RM255,000. Your net profit is RM45,000, so your net profit margin is (RM45,000 ÷ RM300,000) × 100 = 15%.
Operating profit margin
Operating profit margin shows the percentage of revenue left after COGS and operating expenses, but before interest and tax. It isolates how well your core operations perform.
- Operating profit margin = (operating profit ÷ revenue) × 100
With revenue of RM300,000, COGS of RM180,000 and operating expenses of RM60,000, your operating profit is RM60,000. Your operating profit margin is (RM60,000 ÷ RM300,000) × 100 = 20%.
Companies reporting under Malaysian Financial Reporting Standards (MFRS) will soon present operating profit differently. MFRS 18 Presentation and Disclosure in Financial Statements applies for annual periods beginning on or after 1 January 2027 and brings new income statement categories. Many private companies use the Malaysian Private Entities Reporting Standard (MPERS) instead, so ask your accountant which applies to you.
Return on assets (ROA)
Return on assets (ROA) shows how well your business uses its assets to generate profit. It helps you judge whether spending on equipment or stock is paying off.
- ROA = (net profit ÷ total assets) × 100
If your net profit is RM45,000 and your total assets are RM500,000, your ROA is (RM45,000 ÷ RM500,000) × 100 = 9%. Every ringgit of assets generates 9 sen of profit.
Return on equity (ROE)
Return on equity (ROE) measures profit relative to the money the owners have invested in the business. It helps you compare your return with other investment options.
- ROE = (net profit ÷ owner’s equity) × 100
If your net profit is RM45,000 and your owner’s equity is RM200,000, your ROE is (RM45,000 ÷ RM200,000) × 100 = 22.5%.
Earnings before interest, taxes, depreciation and amortisation (EBITDA)
EBITDA adds interest, taxes, depreciation and amortisation back to net profit to show the earnings from your core operations. It’s most useful when you compare businesses with different financing or asset structures.
- EBITDA = net profit + interest + taxes + depreciation + amortisation
Say your net profit is RM45,000, with RM3,000 in interest, RM12,000 in tax, RM8,000 in depreciation and RM2,000 in amortisation. Your EBITDA is RM70,000, or 23.3% of your RM300,000 revenue.
Staff costs often weigh heavily on all of these margins, so review your cost ratios against industry figures to catch problems early.
When to assess your profitability
Assess your profitability at set points in the year and whenever a big decision or cash squeeze comes up.
Plan a profitability review:
- at year end, when you prepare your annual accounts and set next year’s budget
- every quarter, so you can compare margins with the same period last year and adjust prices or costs
- before major changes, such as hiring or taking on a loan
- during financial pressure, when rising costs or slower sales mean you need to know which products still pay their way
Monthly checks are worth adding if your margins are tight or your sales are seasonal.
How to improve profitability
You improve profitability by increasing revenue, reducing costs or both. These strategies suit most small businesses.
Review your pricing
If you haven’t reviewed your prices recently, you may be undercharging. Check your costs and competitors’ prices, then set prices that reflect the value you deliver. Even a small increase can lift your margins.
Cut unnecessary costs
Go through your expenses line by line to find savings. Look for unused subscriptions and suppliers you could renegotiate with.
Improve your sales mix
Some products or services earn better margins than others. Find your highest-margin offerings and focus your marketing and sales there. Consider phasing out low-margin lines that take up time for little return.
Automate repetitive tasks
Manual admin takes time away from work that earns money. Software that handles invoicing, bank reconciliation, expense tracking and payment reminders frees up hours for revenue-generating work.
Track projects against budgets
If you run a service business, scope creep can quietly eat into your margins. Set a budget for each project and raise change orders when clients ask for out-of-scope work.
Keep your customers coming back
Customer retention protects profitability because repeat customers don’t need the same marketing spend to win over. Follow up after each sale and reward loyal customers with extra service or early access to new offers.
Monitor your margins regularly
Check your profitability monthly or quarterly as well as at year end. A profit and loss template or your accounting software’s reports help you spot trends and act while issues are still small.
Track your profitability with Xero
Xero keeps your profitability in view with real-time figures in one place. Bank feeds bring in your transactions automatically, so your revenue and expenses stay up to date.
You can run profit and loss reports whenever you need them and share your financial reports with your accountant. Pick the plan that suits your business and get one month free to try it.
FAQs on profitability
These answers cover common questions small business owners ask about profitability.
How do you benchmark your profitability against your industry?
Compare your gross and net margins with published sector data and ask an accountant who works in your industry about local norms. Compare like with like: the same margin type, for businesses of a similar size.
Can a business be profitable but still fail?
Yes, especially when it grows quickly and ties up cash in stock and unpaid invoices faster than money comes in. Loan repayments and tax bills can also drain cash even when your profit and loss shows a healthy result.
What is the difference between accounting profit and economic profit?
Accounting profit is revenue minus your recorded expenses, while economic profit also subtracts opportunity costs, such as the salary you could earn working elsewhere. If your business makes RM90,000 in accounting profit and you could earn RM70,000 as an employee, your economic profit is RM20,000.
What is another word for profitability?
Common alternatives include earning power, return and profit margin. Lenders and accountants may also talk about your rate of return or financial performance.
When should you seek professional advice about profitability?
Speak to an accountant or financial adviser if your margins fall for two or more quarters in a row and you can’t find the cause. Advice before borrowing or expanding also helps you test how the decision affects your margins.
Related terms
Learn more about profitability
Handy resources
Advisor directory
You can search for experts in our advisor directory
P&L template
Download a P&L 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.