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Profitability in simple terms

On LLC «ElectraQuix» blog, we continue to look at basic economic concepts. In one of the previous posts we told you about the break-even point. Today we will look at such a concept as ‘profitability’. First of all, it serves to control and analyse the financial activity of the company. In other words, profitability can be called economic efficiency. And what is efficiency? It is the achievement of maximum results with minimum effort or cost.
How to calculate profitability
To calculate profitability you need to put the profit in the numerator and what the profitability relates to in the denominator. The result of the division needs to be multiplied by 100 to get the percentage.

For example:
  • Return on investment is calculated using this formula: Profit/Investment*100
  • Return on sales: Profit/ Sales*100
  • Return on equity: Profit/equity*100

Return on investment
Suppose you have decided to invest money and bought a house with the intention of renting it out. Let's assume that you spent 100 thousand conventional units (c.o.o.) on the house, and you plan to charge 700 c.o.o. per month from tenants. Your profit from renting the house for the year will be 700 c.u. multiplied by 12 months - 8400 c.u. Now divide 8400 by 100 thousand and multiply by 100. The result is 8.4%. So the return on your investment leaves 8.4% per year.

This is a calculated figure and it is not a fact that it will be confirmed in reality. However, this result allows you to compare this property investment with other investment options. For example, you can compare this figure with data on bank deposits and then you can decide where to invest your money better, taking into account all other costs: moral, material, physical and time.

Return on equity

Return on equity allows you to understand the return on money working in a company. Again, you can compare this to other companies and other investments, taking into account moral, material, physical and time costs. For example, money in a company works at a return of 5% per year, but a bank deposit returns 9% per year. Why would you want the business then?
Return on sales
This is a very important indicator for business control and planning. A huge number of companies are engaged in trade. Naturally, entrepreneurs want to know how much profit they will get in the future and whether they will get it at all. Profitability of sales will always help to calculate this.

For example, the company for the year reached sales of 1 million U.S. dollars, and its profit reached 200 thousand U.S. dollars. The profitability of sales of this company is 20%. Now planning the next year, you can calculate the profit at the same profitability from any sales volume. The company traded for 1.2 million U.S. dollars. - profit will be 240 thousand c.u., on 1.7 million c.u.. - will receive a profit of 340 thousand U.S. dollars. It is important to remember: the company will get this result if it works exactly the same way and the market conditions do not change. However, you yourself realise that this practically does not happen. Planning and forecasting are considered from reality and take into account possible future changes.

Read other useful publications in our blog: https://electraquix.com.ua/en/blog.
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