Profitability ratios: Measure and improve your business profit

Published Friday 16 January 2026

Table of contents

• What do profitability ratios measure?
• What can profitability ratios tell you?
• Types of profitability ratios
• Using profitability ratios in your business
• Track your profitability ratios with confidence
• FAQs on profitability ratios

Key takeaways

• Calculate gross and net profit margins regularly to monitor how effectively your business converts revenue into profit and identify opportunities to improve pricing strategies or reduce operational costs.
• Utilize return on assets (ROA) and return on invested capital (ROIC) ratios when making significant investments in equipment, property, or research to ensure these expenditures generate adequate returns for your business.
• Track your profitability ratios monthly or quarterly to spot trends early and compare performance against your own historical data and industry benchmarks to identify areas for improvement.
• Implement accounting software to automate profitability ratio calculations and display them on dashboards, enabling you and your accountant to monitor financial performance in real time without manual calculations.

What do profitability ratios measure?

Profitability ratios are financial metrics that show how efficiently a business turns its spending into profits. Different types of ratios focus on different types of spending. Not all ratios will be relevant to every small business.

What can profitability ratios tell you?

Profitability ratios give you a clear picture of your business’s financial health. They go beyond just looking at your total profit and help you understand where that profit is coming from and how efficiently you’re generating it.

By tracking these numbers, you can answer important questions like:

• Is my pricing strategy effective?
• Are my production costs too high?
• Am I getting a good return from my investments in equipment or property?
• How does my performance compare to previous years or industry benchmarks? For instance, one company tracked its performance against a property index, finding it had exceeded the MSCI IPD UK All Property Index by 29% over a five-year period.

These insights are vital for making smarter strategic decisions, whether you’re looking to grow, improve efficiency, or simply maintain a healthy financial position.

Types of profitability ratios

Profitability ratios are divided into two main categories: margin ratios and return ratios. Each category focuses on a particular type of spending.

Margin ratios

Margin ratios focus on your day-to-day spending (operating expenditure). They show what percentage of revenue your business keeps after covering costs. This reveals how much money stays in your business versus what goes out the door.

The two main margin ratios are:

• Gross profit margin
• Net profit margin

Return ratios

Return ratios focus on large investments like equipment, property, or research and development. They’re more relevant to businesses that are growing quickly. These ratios help you measure the return on major investments.

The two main return ratios are:

• Return on assets (ROA)
• Return on invested capital (ROIC)

Gross profit margin

Gross profit margin shows what percentage of revenue remains after paying for the things you sell (cost of sales). Your gross margin needs to be substantial because you’ll use this cash to pay general expenses like:

• rent and utilities
• marketing and advertising
• insurance and administration
• other operating costs

Why it matters

A higher gross margin means you hold onto a bigger share of sales revenue. This gives you more room to pay general costs and still bank a net profit.

Monitoring your margins helps you protect your long-term sustainability and spot opportunities to improve performance, such as one real estate company that achieved a 1.7 percentage point higher margin on land acquisitions compared to its initial expectations.

Formula for calculating gross profit margin ratio

Learn more in our guide How to measure profitability.

Get tips to improve these ratios in our guide 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 sales you actually keep in your business. You can pay this money to owners or reinvest it in growth.

Why it matters

A higher net profit margin means you’re efficient at turning sales into profits. Higher net margins make you less reliant on very high sales volumes, which helps smaller businesses that cannot rely on selling in bulk.

You can use several strategies to adjust your margins:

• Lower prices to increase sales volume and drive higher total profits
• Maintain prices and spend more revenue on marketing to attract new business
• Invest in staff so employees can make business operations easier

It’s a delicate balance that requires careful consideration.

Formula for calculating net profit margin ratio

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

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

Learn more in our guide How to measure profitability.

Get tips to improve these ratios in our guide How to increase profit.

Return on assets

Return on assets (ROA) shows how effectively you make money from your assets like property, work tools, and equipment. This ratio can get technical. It’s probably only relevant if you have significant investments in expensive equipment, real estate, or intellectual property.

Why it matters

ROA tests how efficiently your investments generate profit. A high ratio suggests you’re getting good value from your assets. A lower ratio may indicate you could use your assets more efficiently in some areas.

Formula for calculating return on assets ratio

* 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.

* 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.

Return on invested capital

Return on invested capital (ROIC) shows how effectively you make money from new investments. This ratio is technical and only relevant if you’re spending significantly on:

• property and buildings
• equipment and machinery
• intellectual property
• research and development

Why it matters

ROIC shows whether your assets and projects are delivering the returns you expect. This helps you focus future spending on investments that create more value.

Formula for calculating return on invested capital ratio

* 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.

* 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.

Using profitability ratios in your business

Profitability ratios allow small businesses to measure how efficiently they turn costs and investments into profit. It’s especially helpful to track your gross and net profit margins, as they’re key to keeping your business running day to day.

Measure your ratios to understand your current performance. Use these results to set:

• Benchmarks: Ratios you’d like to maintain
• Goals: Ratios you’d like to achieve

ROA and ROIC may become relevant as your business grows. Even if you don’t formally measure them, keep the principles in mind. Investments need to pay for themselves and then some.

Work with accountants or bookkeepers to determine which ratios are most relevant to your business. They can run the calculations and easily share reports with Xero accounting software.

Track your profitability ratios with confidence

Understanding profitability ratios gives you powerful insights into your business performance. Start by monitoring your gross and net profit margins monthly to spot trends and opportunities.

Ready to simplify your financial tracking? Xero's accounting software automatically calculates profitability ratios from your business data. Try Xero for free.

FAQs on profitability ratios

Here are answers to some common questions about using profitability ratios in your business.

What is a good profitability ratio?

There’s no single ‘good’ number, as it varies widely by industry, business size, and age. The best approach is to compare your ratios against your own historical performance to track improvement.

You can also look for industry benchmark reports to see how you stack up against similar businesses, which can reveal both outperformance and underperformance. For example, one investment group found its total property return was 5.5% for the year, while the benchmark produced a total return of 8.2%.

How often should I calculate profitability ratios?

It’s a good practice to review your key profitability ratios, like gross profit margin and net profit margin, on a monthly or quarterly basis. This allows you to spot trends and address issues quickly. Return ratios like ROA might be reviewed less frequently, perhaps annually or after a major purchase.

Can I have a high gross profit margin but a low net profit margin?

Yes, this is a common scenario. It means you’re doing a great job of pricing your products or services and controlling production costs, but your operating expenses (like rent, marketing, and salaries) are eating up too much of that profit. It’s a clear signal to review your overhead costs.

What’s the difference between profitability and liquidity ratios?

Profitability ratios measure how well your business generates profit from its sales and assets. In contrast, liquidity ratios (like the current ratio) measure your ability to pay off your short-term debts.

While acceptable ratios vary by industry, experts suggest that a company should aim for a current ratio that should exceed 2:1 to safely meet its liabilities, according to ACCA guidance on ratio analysis.