# profitability

Profitability ( english profitability ) is the generic term for a number of economic indicators that the assessment of the economic success of a company are.

## General

Profitability is one of the most important metrics and is usually given as a percentage . This percentage is intended to express what percentage one reference value makes up from another reference value. Profitability is therefore a ratio . In the most general form of the generated will win the set to make a profit capital compared:

${\ displaystyle {\ text {Profitabilit}} \ mathrm {\ ddot {a}} {\ text {t}} = {\ frac {\ text {Profit}} {\ text {Capital}}}}$.

Profitability is an important benchmark for measuring, analyzing, monitoring and planning success. The term return is often understood as a synonym for profitability, although it can be better described as the annual total return of an investment and is therefore more related to finance .

## history

For Joseph Schumpeter , in 1907 every entrepreneur produced “... to the limit of profitability, ie such an amount that another addition would bring him loss.” However, Schumpeter did not mean profitability here, but a situation in which the marginal cost curve intersects the marginal revenue curve . The method of return on investment - the profitability of the total capital employed - was developed in 1919 by the DuPont Group , which developed a target hierarchy of several profitability indicators and their interactions with liquidity using the DuPont key figure system. Return on capital played the main role at Heinrich Nicklisch in 1922. In 1926 Josef Hellauer saw profitability as “the ratio of the net income of a company to the capital invested in it”. In business administration , since Hellauer, profitability has consistently been understood as a return on capital.

## Profitability ratios

Different types of profitability must be distinguished depending on the selected reference value .

### Return on equity

The return on equity (short: EKR , also: return on equity , entrepreneurial profitability ; English return on equity , abbreviated: ROE ) documents how the equity of a company has earned interest within an accounting period. An entrepreneur or partner ( shareholder ) can use the return on equity to see whether his investment in the company is profitable. For the calculation, the annual surplus (after taxes) is set in relation to the equity available at the beginning of the period : Investors can use the return on equity in conjunction with other key figures to provide information on future corporate development. An exceptionally low EKR often indicates overvalued assets (with the risk of future write-downs ) or unprofitable tied-up capital, for example in high inventories or fixed assets that are no longer necessary for business operations . An exceptionally high EKR, provided it is not based on an extraordinary market position of the company, usually reflects a temporary exceptional situation, for example due to extraordinary income or a cyclical high point. If corporate profits can be reinvested with constant profitability, the EKR - adjusted for extraordinary results and taking into account the dividend ratio - allows conclusions to be drawn about future profit growth.

${\ displaystyle {\ text {Return on Equity}} \ mathrm {\ ddot {a}} {\ text {t}} = {\ frac {\ mathrm {Profit}} {\ text {Equity}}}}$.

Since only the permanently achievable and operating profit, adjusted for extraordinary effects as well as interest and tax payments, is a decisive parameter for determining profitability, the return on equity can also be determined by comparing it with EBIT :

${\ displaystyle {\ text {Return on equity}} \ mathrm {\ ddot {a}} {\ text {t}} = {\ frac {\ mathrm {EBIT}} {\ text {Equity}}}}$.

#### Leverage effect

If outside capital is added to equity and the profit rises as a result, the return on equity also rises. This effect is called the leverage effect . As long as the total cost of capital / return is higher than the cost of debt, the return on equity increases with increasing debt. However, the greater use of outside capital increases the interest rate risks and the break- even point , so that there is a risk of reduced profits or even losses if there are fluctuations in employment .

### Return on investment

The return on assets (short: GKR , also: return on assets, return on assets, return on investment, corporate profitability, corporate earnings , English return on assets, ROA ) indicates how efficiently the capital investment was an investment project within a billing period. By using this key figure, the disadvantages of return on equity, and thus those of the leverage effect , can be avoided.

The following applies to the return on total capital:

${\ displaystyle {\ text {Return on total capital}} \ mathrm {\ ddot {a}} {\ text {t}} = {\ frac {{\ text {Net profit}} + {\ text {Interest on borrowed capital}}} {\ text {Total capital}}} = {\ frac {{\ text {net profit}} + {\ text {interest on borrowed capital}}} {{\ text {equity}} + {\ text {borrowed capital}}}} \,}$.

Total capital consists of equity and debt and is listed on the liabilities side of the balance sheet. Debt capital means loan debts, short-term bank debts, liabilities and provisions. The net profit is determined by means of the income statement (P&L). Borrowing costs are business expenses and reduce net profit.

### Return on sales

The net return on sales (also: return on sales ; English return on sales , ROS, operating profit margin ) is the ratio of profit to sales within one accounting period and should not be confused with the gross margin , which the gross profit consists of sales in relation to sales . From this, the viewer recognizes what percentage of sales has remained as profit. Example: A return on sales of 10% corresponds to a profit of 10 cents per euro of sales. If there are no extraordinary factors, the return on sales provides an indication of a company's market position . The more distinctive its unique selling points , the greater the achievable return on sales. A weak return on sales - in the lower single-digit percentage range - usually indicates a hard-fought, highly competitive market. The profits of companies with a high return on sales are less susceptible to fluctuations in exchange rates, interest rates, raw material prices and other expense items .

${\ displaystyle {\ text {Net return on sales}} = {\ frac {\ text {Profit}} {\ text {Sales}}}}$.

In the case of a self-employed person , the profit minus the imputed entrepreneur's wages is to be set.

variants

If the return on sales is calculated as stated above, the taxes due on the profit are already deducted and therefore also include fluctuations in the tax rate, for example in the case of additional tax payments or the use of loss carryforwards. For the comparative assessment of the profitability of different companies or accounting periods , the profit before tax is helpful as a basis, the gross return on sales or the pre-tax margin :

${\ displaystyle {\ text {Gross return on sales}} = {\ frac {\ text {Profit before taxes}} {\ text {Sales}}}}$.

An even more extensive normalization also ignores the cost of debt and calculates the EBIT margin ( EBIT : earnings before interest and taxes) as a measure of operational profitability.

## applicability

These profitability indicators can be determined across industries in every type of company. They serve as a basis for making decisions within the company and for comparison with competitors and are aggregated as key figures for each individual industry . At credit institutions - because of their completely different structures compared to non-banks - there is the interest margin as a key figure . In the case of insurance , the profit after tax is compared with the solvency ratio.

## literature

• Alisch Katrin, Eggert Winter, Ute Arentzen: Gabler Wirtschaftslexikon . 8 vols. Gabler-Verlag, 2005, ISBN 3-409-10386-4 .

## Individual evidence

1. Horst-Thilo Beyer (Ed.), Finanzlexikon , 1971, p. 293 f.
2. Gabler Verlag (ed.) / Katrin Alisch, Gabler Wirtschaftslexikon , Volume 5, 2005, p. 1015, ISBN 3-409-10386-4
3. Joseph Schumpeter, in: Schmollers Jahrbuch 1907 , p. 596
4. Ulrich Breicht, Business Studies for Managers , 2012, p. 51
5. Ulrich Breicht, Controlling for Managers , 2013, p. 156
6. ^ Heinrich Nicklisch: Wirtschaftliche Betriebslehre , 1922, p. 224 ff.
7. ^ Josef Hellauer, ZfB 1926, p. 518
8. FAZ: Return on Equity - What is it? Retrieved February 17, 2011 .