How is the profitability of the enterprise calculated
Profitability is a key indicator of a commercial organization. It is necessary in the preparation of a business plan, cost accounting, setting prices, as well as to understand how profitable a business is. Profitability are interested lenders and investors when making decisions about cooperation with the company. In this regard, you need to know how to calculate the profitability of the enterprise.
What is profitability?
Profitability is a relative value that shows how efficiently an enterprise manages available funds (assets, capital, fixed assets, etc.). It is measured as a percentage and is calculated by dividing the profit by the corresponding base. Profitability is not calculated in case of loss, and therefore never takes a negative value.
The greater the value obtained, the more efficient the business, and the more profitable it looks in the eyes of business partners. There are no profitability standards, however there are optimal average statistical indicators by industry, country, etc.
The profitability index is calculated using the same formulas for both existing companies and start-ups. In the first case, the actual data are used, and in the second – the predicted.
How to determine the level of profitability?
Profitability is calculated on the basis of direct indicators, as well as on accounting reports. If it is necessary to determine this indicator for a foreign enterprise, then open information presented in the balance sheet is used. Serious contracts often imply the right of a business partner to receive accounting reports from its counterparty.
If profitability is calculated for a startup, then a comprehensive marketing analysis of the market is needed. First of all, on the basis of the analysis of the consumer audience, competitors and the degree of attractiveness of the project, it is necessary to determine the expected size of revenues. It is also necessary to have on hand the estimated size of investments, assets and expenses.
Profitability calculations cannot be considered as an end result: they must be considered for different periods (for example, quarterly) and studied in dynamics. In addition, it is necessary to carry out the analysis in conjunction with real events in the company, because by itself, profitability does not give an idea of what influenced the dynamics of profits: increased productivity, a good marketing campaign, or another factor.
Profitability is not a single indicator. It is calculated on several bases:
sales;
assets;
equity;
investments;
production and so on
In each of the above examples, the company’s profit is divided into one or another base and multiplied by 100%. As a rule, counterparties are interested in indicators for sales (including EBITDA for primary profit), assets and capital. Other indicators can be calculated as part of an internal audit.
Return on sales
The sales profitability indicator indicates the percentage of profits accounted for by the total amount of goods or services sold. This indicator gives the most general idea of the company’s affairs and is distinguished by the most intensive dynamics: the periods of its increase are quickly replaced by the periods of fall.
The formula has the following form:
P = PE / OP, where P – profitability, PE – net profit and OP – revenue (sales).
Note! The higher the value of the indicator, the better, but it strongly depends on the specific industry. Therefore, companies from different industries should not be compared according to this criterion: for example, pharmaceutical and computer equipment manufacturing. At the same time, each of these two companies can be compared with other firms representing their respective industries.
The reason for the growth of the indicator can be both an increase in profits and a decrease in sales. The simultaneous impact of these two factors is also possible. Profit can grow due to increased prices, lower costs, reduced depreciation, etc.
The decline in sales may occur for various reasons. If it is observed after raising prices, then this phenomenon can be considered natural. If the reason is the loss of buyers’ interest in the company’s products, then business partners should be alerted.
EBITDA margin
The profitability of a commercial enterprise is estimated not only by net profit, but also by primary profit, i.e. one from which interest, taxes and depreciation have not yet been deducted.
The formula looks like this:
EBITDA margin = EBITDA / OP, where EBITDA margin is the profitability of sales by primary profit, EBITDA is the size of the primary profit, OP is the volume of sales in money terms.
Modern analysts are increasingly using this indicator, because it reflects the level of the profits that the company receives before.
