Profitability

Profitability shows how effectively a company generates a return on the capital invested in assets, operations, and development. It is an overall measure of how much return the company generates in relation to the resources tied up in its operations. High profitability is a sign of a strong economy and efficient operations, while low profitability may indicate inefficient use of capital or weak earning capacity.

What does profitability measure?

Profitability is about the company's ability to convert capital into profit. It shows how well the company is generating returns on both the owners' and lenders' money.

A highly profitable company effectively creates value from the capital at its disposal. Low profitability, on the other hand, can be a sign of:

• high costs
• low earnings
• overinvestment in assets
• inefficient operation

Profitability is typically assessed using a number of key figures, of which return on assets (ROA) is the most important.

Formula box – profitability in figures

Return on assets (ROA):
Earnings before interest ÷ Average assets × 100

Profit margin (PM):
Operating profit ÷ Revenue × 100

Asset turnover ratio (AOH):
Net sales ÷ Average assets

Debt interest rate:
Financial costs ÷ Average debt × 100

Return on equity (ROE):
Profit before tax ÷ Average equity × 100

These key figures each shed light on a different aspect of profitability and are often used in combination when analyzing a company in depth.

Why is profitability important?

Profitability shows whether the company generates a return that is commensurate with the risk taken by investors and lenders. High profitability typically means that the company:

• are in a stronger competitive position
• have better access to financing
• can invest in growth
• are more resilient to economic fluctuations

Conversely, low profitability can be a warning sign that the company is not making sufficient use of its capital.

Profitability and other key figures

Profitability is closely linked to key operating ratios such as EBIT, EBITDA, and profit margin.

• EBIT and EBITDA show earnings from operations.
• The profit margin shows how much of the revenue ends up as operating profit.
• The rate of return shows how much return the company generates from its assets.

Profitability builds on these figures and provides a picture of how effectively the company uses its total resources.

Profitability in practical analysis

When assessing profitability, the following factors are often considered:

• development over several years
• return relative to the industry average
• the relationship between earnings and capital tied up
• the effect of financing and debt
• risk-return ratio

For example, a company may have high turnover and strong margins, but low profitability if its capital commitment is too high.