How to calculate profitability: calculation example, formula and key indicators

The profitability of the company - a set of factors by which you can judge how efficiently the organization’s management uses its assets to make a profit. Calculation and analysis of profitability is an important economic task.

General information

Depending on which aspect of the firm's work needs to be quantified, various profitability indicators are used.

For example, you can evaluate:

• company work;
• production activities of the company;
• resource efficiency.

This is the task of calculating profitability.

In any case, you will have to start with the calculation of the balance sheet (statements of profit and loss of the company), which is the source information for identifying all indicators. Additionally, other management accounting data may be taken into account. For what? For example, to calculate the profitability of the activity or the threshold of profitability.

Calculation algorithm

The concept of profitability can be given two definitions:

1. The ratio between investments and the profit received from them.
2. The ratio between the costs of maintaining the company and profit.

Profitability is calculated taking into account several parameters, including:

• assets;
• production assets;
• investments;
• total investments;
• sales of products.

Profitability is calculated using the following formula:

P = (P / V _a ) * 100%,

where P is the profitability, P is the net profit for the accounting period, _{and a} is the total value of the assets.

This methodology for calculating profitability will be used later. In particular, in the calculation of other efficiency factors. Below on an example of a formula for calculating profitability, more clear explanations will be given.

Calculation of production costs

Above is a mention of the source information for calculating profitability using the balance sheet. In a professional language, it is called Form 2 of Accounting Statements (GTC). The data of this form, as well as other management information - all this is used in calculating the profitability of a business in various areas.

The calculation of the cost of production is as follows:

1. The amount of net profit is calculated.
2. The calculated amount is divided by gross transaction costs. This parameter illustrates the production efficiency of the entire organization.
3. The base of distribution of various types of costs by types of products is calculated.
4. The revenue and transaction costs for each type of product are calculated separately.
5. The amount of net profit for each type of product is calculated. This is done by deducting from the proceeds the sum of operating and the share of administrative as well as commercial costs.

Calculation of return on assets

The calculation of the rate of return on assets is carried out according to the following algorithm:

1. Net profit is calculated.
2. The amount of interest paid for the calculated period is calculated in the form of 2 financial statements.
3. The size of the assets at the beginning and end of the calculated period in the balance sheet is found.
4. Using the data obtained, profitability is calculated according to the formula given in the section “Calculation Algorithm”.

Sales performance calculation

Sales performance is calculated even easier than production or asset efficiency. A step-by-step instruction for calculating sales performance looks like this:

1. The amount of net profit for the reporting period is calculated.
2. The size of sales for the calculated period is calculated.
3. The parameter calculated in the first paragraph is divided by the parameter calculated in the second paragraph.

Profitability Threshold Calculation

Profitability threshold in a professional language is called the breakeven point. This parameter characterizes the object of production, in which the profitability is zero, therefore, the company does not receive profit and does not suffer loss at the same time.

This indicator helps to evaluate the overall performance of the company: if the volume of production exceeds the threshold of profitability, the company works efficiently and is profitable, if the volume does not exceed this indicator, the company is unprofitable.

To calculate the breakeven point, you need data such as:

1. The amount of fixed costs.
2. Unit price.
3. The sum of the variable costs per unit of goods.

In order for the calculation of profitability ratios to be correct here, it is necessary to take into account the structure of all types of costs. Most often it looks like this:

1. Administrative costs do not depend on the volume of products and sales, they relate to fixed costs.
2. Selling costs include both fixed (advertising costs) and variable (bonuses to employees for additional sales) components.
3. Production costs can also be constant (rental of equipment and premises) and variables (costs of materials, utility bills or payroll).

Profit is calculated using a simple formula. It is equal to the difference between the company's revenue and total costs (the sum of fixed and variable costs):

profit = revenue - fixed costs - variable costs

Variable costs are the product of variable costs per unit of product by the number of manufactured products:

variable costs = variable costs per unit of goods * quantity of output

Revenue is the product of the price of a unit of production by the number of output.

To calculate fixed costs (from the definition of the break-even point), it is necessary to subtract from these revenues the same fixed costs (taken as an unknown number in the equation) and variable costs. This difference must be equal to zero and express fixed costs.

The result is the following formula:

fixed costs = quantity of production * (price per unit of goods - variable costs per unit of production)

The threshold of profitability is the quotient of dividing fixed costs by the difference in the price of a unit of production and variable costs per unit of goods:

profitability threshold = fixed costs / (unit price - variable costs per unit of goods)

Types of Efficiency

It is also worth considering in more detail the types of profitability that are usually calculated. The following types of efficiency will be described in detail below:

• sales
• assets;
• investment;
• cost price;
• staff.

Sales performance

In foreign literature, this parameter is denoted by ROS. This ratio is calculated as the ratio of net profit to revenue.

With the help of the sales efficiency coefficient, you can evaluate how well the company is able to profit from its activities. For this indicator, various companies are often compared.

Asset Use Efficiency

The abbreviated foreign designation is ROA. To calculate the efficiency coefficient in this case, you need to know the following parameters:

• the amount of assets at the beginning and assets at the end of the period under review (Sum);
• the product of interest paid on (1 - N _pr ), where N _pr is the tax rate on profit (Prod).

The formula for calculating the profitability of the enterprise in terms of the use of assets:

return on use of assets = ((net profit * Sum) * 2 / Prod) * 100%

The parameter is calculated as a percentage for ease of comparison with the effectiveness of enterprises with different ratios of equity and borrowed capital.

Investment Effectiveness

This ratio is calculated for entrepreneurs who want to invest their money in any business. The latter, with the help of this profitability ratio, can be convinced of how profitable it is to invest money in this or that enterprise.

The coefficient of investment efficiency is calculated as the quotient of dividing the difference between net profit and taxes by the total invested capital. For ease of use, this parameter is calculated as a percentage.

The formula is as follows:

ratio = ((net profit - taxes) / total investment) * 100%

Under the total investment refers to the equity of the company and long-term obligations that it has undertaken.

Product Cost Efficiency

This concept is a set of indicators that help evaluate the operating activities of the enterprise, that is, activities that do not take into account investment and financial components.

The formula for calculating cost-effectiveness is simple. It is necessary to divide the profit into operating costs:

cost-effectiveness = profit / transaction costs

Why is cost-effectiveness a combination of indicators? Because profits can be different:

• clean
• operating room;
• operating expenses before taxes, interest and depreciation charges.

As for transaction costs, they can also be calculated in several ways:

• assessing the cost of production;
• assessing the cost of sales.

Staff performance

This performance ratio helps to evaluate the effectiveness of the company in the operational plan. To calculate the efficiency ratio, you need to double the net profit divided by the sum of the number of personnel at the beginning of the calculated period and the number of personnel at the end of this period:

efficiency ratio = 2 * net profit / (number of employees at the beginning of the period + number of employees at the end of the period)

Using this coefficient, the performance of companies operating in the same industry is often compared.

Profitability calculation example

To clearly explain the above terms, it is worth using them to evaluate the effectiveness of the three conventional companies. An example of calculating profitability is shown in the table below (indicators are given in arbitrary units).

What conclusions can be drawn on these indicators? It is obvious that the example of calculating the profitability of sales efficiency demonstrates that company B is a clear outsider in the competition.

The leader in terms of asset utilization is Company B. With assets of 150 conventional units, she derived 77 conventional units of profit, which is an excellent indicator. According to this indicator, it can be judged that company “A” very poorly manages its assets.

An example of calculating the profitability of capital shows that company “B” is also a leader in this area, and the big difference between the efficiency of the use of assets and the efficiency of the use of capital proves the company's ability to sell equity well.

By comparing all the parameters, you can find out which company is better to invest money in, and where management change is clearly required to implement more effective management.

About company assets

There are various sources of financing assets, which together constitute liabilities of the enterprise. The latter are displayed in the accounting report of the company. Liabilities comprise:

1. Equity of the company: retained earnings and reserve funds.
2. Long-term liabilities: borrowed capital, money received from investors, owners or the borrower. Of course, they must be returned by a certain date.
3. Short-term liabilities: current debts of the company to various legal entities such as suppliers or customers, government organizations (taxes) and employees (salaries and social benefits).

From the equity of the organization and long-term liabilities are aggregated investments (another name - total capital). They represent money that has been invested for a long time in the activities of the company by any persons (owners or borrowers, for example).

Conclusion

Profitability - a set of coefficients of a firm's performance in various areas from investment and sales management to employee management. This is the task of calculating profitability. Using the coefficients presented in the article, potential investors can determine the feasibility of financial investments in a particular company.