III. Profitability Ratios :

Efficiency of a business is measured by profitability. Profitability ratio measures the profit earning capacity of the business concern. The important profitability ratios are discussed below:

1. Gross Profit Ratio
2. Net Profit Ratio
3. Operating Profit Ratio
4. Operating Ratio

1. Gross Profit Ratio

This ratio indicates the efficiency of trading activities. The relationship of Gross profit to Sales is known as gross profit ratio. The ratio is calculated as:

Gross profit is taken from the Trading Account of a business concern. Otherwise Gross profit can be calculated by deducting cost of goods sold from sales. Sales means Net sales.

Illustration :
From the following particulars ascertain gross profit ratio

Rs. 

Cash sales                                                                                                    40,000

Sales return                                                                                                  5,000
Credit sales                                                                                                 65,000

Gross profit                                                                                                40,000

Solution:

2. Net Profit Ratio:

This ratio determines the overall efficiency of the business. The relationship of Net profit to Sales is known as net profit ratio. The ratio is calculated as:

Net profit is taken from the Profit and Loss account of the business concern or the gross profit of the concern less administration expenses, selling and distribution expenses and financial expenses.

Illustration : 

Calculate net profit ratio from the following:

Rs.

Net Profit                                                                                                     60,000
Sales                                                                                                            3,00,000

Solution:

3.  Operating  Profit Ratio

This ratio is an indicator of the operational efficiency of the management. It establishes the relationship between Operating profit and Sales. The ratio is calculated as:

Where operating profit is Net profit + Non-operating expenses – – Non-operating income.

Where, Non-operating expenses are interest on loan and loss on sale of assets.

Non-operating income are dividend, interest received and profit on sale of asset. (or) Operating profit = Gross profit –– Operating
expenses.

Operating expenses include administration, selling and distribution expenses. Financial expenses like interest on loan are excluded for this purpose.

Illustration : 

Calculate the operating profit ratio from the following:

Rs.

Net Profit                                                                                                    3,00,000
Loss on Sale of Furniture                                                                           10,000
Profit on sale of investments                                                                   30,000
Interest paid on loan                                                                                 30,000
Interest from investments                                                                       20,000
Sales                                                                                                           5,80,000

Solution:

4. Operating Ratio

This ratio determines the operating efficiency of the business concern. Operating ratio measures the amount of expenditure inurred in production, sales and distribution of output. The relationship between Operating cost to Sales is known as Operating Ratio. The ratio is calculated as:

Illustration : 

From the following details, calculate the operating ratio.

Rs.

Cost of goods sold                                                                                   6,00,000
Operating expenses                                                                                   40,000
Sales                                                                                                            8,20,000
Sales returns                                                                                                20,000

(Note: All profitability ratios will be expressed in terms of percentage.)