Profitability Ratios

Profitability ratios answer the question: how efficiently is the company converting inputs into profit? They can be computed at different levels of the P&L (gross, operating, net) and at the level of the balance sheet (how much return on capital deployed).

Margin ratios (gross margin, EBITDA margin, PAT margin) show operating efficiency, what percentage of every rupee of revenue survives as profit. Return ratios (ROE, ROA, ROCE) show capital efficiency, how much profit is generated per rupee of capital employed.

For an equity investor, return ratios are ultimately more important than margin ratios. A company with low margins but very high asset turnover can generate excellent returns on capital. The textile and trading businesses often work this way, thin margins, fast inventory turns, strong ROCE.

Margin ratios:

• Gross Profit Margin = Gross Profit ÷ Revenue: Reflects pricing power and input cost management
• EBITDA Margin = EBITDA ÷ Revenue: Operating efficiency before financing and depreciation
• EBIT Margin = EBIT ÷ Revenue: Reflects D&A intensity (higher for capital-heavy businesses)
• PAT Margin = PAT ÷ Revenue: Bottom-line efficiency after all costs

Return ratios:

• ROE = PAT ÷ Average Shareholders' Equity: Return on shareholders' investment. Sustainable ROE > cost of equity creates value.
• ROA = PAT ÷ Average Total Assets: Overall asset efficiency. Key for banks (typical range: 1–2% for good Indian banks).
• ROCE = EBIT × (1−t) ÷ Average Capital Employed: Return on all capital (equity + debt). Capital Employed = Total Assets − Current Liabilities. Best for comparing capital intensity across companies.
• ROIC = NOPAT ÷ Invested Capital: NOPAT = EBIT × (1−t). Most precise for economic value analysis.