Apart from the creditors, both short-term and long-term, also interested in the financial soundness of a firm are the owners and management or the company itself. The management of the firm is naturally eager to measure its operating efficiency. Similarly, the owners invest their funds in the expectation of reasonable returns. The operating efficiency of a firm and its ability to ensure adequate returns to its shareholders/owners depends ultimately on the profits earned by it. The profitability, of a firm can be measured by its profitability ratios. In other words, the profitability ratios are designed to provide answers to questions such as (i) is the profit earned by the firm adequate? (ii) what rate of return does it represent? (iii) what is the rate of profit for various divisions and segments of the firm? (iv) what are the earnings per share? (v) what was the amount paid in dividends? (vi) what is the rate of return to equity-holders? and so on.
Profitability ratios can he determined on the basis of either sales or investments. The profitability ratios in relation to sales are (a) profit margin (gross and-net) and (b) expenses ratio. Profitability in relation to investments is measured by (a) return on assets, (b) return on capital employed, and (c) return on shareholders equity.