When it comes to managing your expenses and your increasing profitability it is essential to measure your business’s financial performance. With the many different variations of metrics used to measure success, it can become quite overwhelming to small business owners. Luckily, we’ve curated a list of the most important financial indicators for small business success.
Firstly, what are profitability ratios?
These ratios measure your businesses ability to earn profitability. It takes into account things such as:
- sales revenue
- operating expenses (OPEX)
- balance sheet assets
- shareholders’ equity
They also show you how well you make use of existing assets to make a profit if the business has shareholders. Below are 5 profitability ratios any business can use to track its success:
Gross Profit Margin
The gross profit margin is the most widely used margin ratio. This margin ratio calculates the amount left over after covering the cost of goods sold (CoGS). All the information needed to calculate this will be found on the business’s income statement. Higher gross profit reflects a high efficiency of earning revenue and covering business expenses, their taxes and depreciation.
Calculation:
gross profit margin = (total sales – cost of goods sold) ÷ total sales
Operating Profit Margin
This margin is also known as earnings before interest and taxes (EBIT). It looks at earnings as a percentage of sales before deducting interest and taxes. It is calculated by subtracting your operating costs, such as rent, utilities, salaries, administrative and general costs, by your gross profit. The operating profit margin is usually used as an assessment tool that determines how well the business can adapt to a possible slowdown. It can also determine profitability for seasonal businesses.
Calculation:
operating profit margin = operating profit ÷ revenue
Calculation:
gross profit margin = (total sales – cost of goods sold) ÷ total sales
Net Profit Margin
This calculation shows how much profit the business has made after all expenses are paid, including operating and non-operating expenses. If your business has a high net profit margin it is an indication that the company is operating successfully and generating an income, indicating that you are successfully managing costs and pricing your goods or services. Your income statement will provide the figures needed.
Calculation:
net profit margin = net income ÷ revenue
Return on Assets
This margin focuses on making use of assets to generate profit. This is important information as it informs the business how well they make use of their assets and resources that generates a profit.
Calculation:
return on assets = net income ÷ total assets
Return on Equity
This calculation is important for shareholders and investors, as it measures the return on investment that investors have put into the business which proves to be useful when trying to gain new investors. Your income statement will provide the figures needed.