We explain what profitability is and the types of profitability that are distinguished. Also, its indicators and their relationship with risk.
What is profitability?
When we talk about profitability, we refer to the ability of a given investment to yield returns greater than those invested after waiting for a period of time. It is about a fundamental element in economic and financial planning since it means having made good choices.
Profitability exists, then, when a significant percentage of the investment capital is received, at a rate considered adequate to project it over time. The profit obtained through the investment will depend on this and, therefore, will determine the sustainability of the project or its convenience for the partners or investors.
A distinction is commonly made between economic, financial and social profitability:
- Economic profitability It has to do with the average profit of an organization or company with respect to all the investments it has made. It is usually represented in percentage terms (%), based on the comparison between the overall investment and the result obtained: costs and profit.
- Financial profitability. This term, on the other hand, is used to differentiate from the previous one the benefit that each partner of the company receives, that is, the individual ability to obtain profit from their particular investment. It is a measure closer to investors and owners, and is conceived as the relationship between net profit and net worth of the company.
- Social profitability. It is used to refer to other types of non-fiscal gain, such as time, prestige or social happiness, which are capitalized in ways other than monetary gain. A project may not be economically profitable but it may be socially profitable.
See also: Financial statements
Profitability indicators
The indicators of profitability (or profitability) in a business or a company are those that serve to determine the effectiveness of the project in generating wealth, that is, they allow you to control the balance of expenses and benefits and thus guarantee the return.
The profitability indicators are:
- Net profit margin It consists of the relationship between the company's total sales (operational income) and its net profit. The return on assets and equity will depend on this.
- Gross profit margin It consists of the relationship between total sales and gross profit, that is, the remaining percentage of operating income once the cost of sales has been discounted.
- Operational margin It consists of the relationship between total sales, again, and operational profit, so it measures the performance of operational assets in the development of its corporate purpose.
- Net return on investment It is used to evaluate the net profitability (use of assets, financing, taxes, expenses, etc.) generated on the company's assets.
- Operational profitability on investment Similar to the previous case, but evaluates operational profitability instead of net profitability.
- Return on equity Evaluates the profitability of the organization's owners before and after facing taxes.
- Sustainable growth It aims for the growth in demand to be satisfied with growth in sales and assets, that is, it is the result of the application of sales, financing, etc. policies. of the company.
- EBITDA This is the net cash flow of the company before taxes and financial expenses are settled.
Profitability and risk
The risk of an asset or a company depends on your ability to generate return that is, to provide profits and comply with all the agreed financial terms, once the maturity date has been reached.
Thus, it is the product of an evaluation of the probability of payments: the greater the possibility of non-payment or breach of contractual terms, the greater the assigned risk margin.
This indicator not only It is used to evaluate the economic profitability of companies but also of the countries. The risk margin of each entity will depend on the solvency they present to their creditors and the guarantees that are incorporated into the title.
