Posted in Finance, Accounting and Economics Terms, Total Reads: 316
Definition: Profit Ratio
Profit ratio calculates the ratio between the profit and the sales within a particular time frame. Profit ratio can be gross profit ratio or net profit ratio. Gross profit ratio calculates the profit ratio between gross profit and sales whereas net profit ratio calculates the ratio between net profit and sales.
The profit ratio is also called the profit margin.
The formula for calculating profit ratio is:
Profit Ratio = Profit for a period/ Sales for that period
The profit ratio basically calculates the return on sales. It is used to analyse the return that a company earns on a particular level of sales. The profit margin ratio shown what percentage of sales are left over after all expenses are paid off by the business.
The profit ratio is used by the outside world to judge the efficiency of the business. The creditors use it to judge how effectively a company can convert its sales into income. Investors use it to make sure that the company has enough profits to pay back its loan. The shareholders use it to judge if company has enough profits to distribute dividends. A low profit ratio would indicate that the company has high expenses and the management needs to control the expenses and cut them in order to earn profits. This ratio is also used by the internal management to set performance goals for the future.