Accounting International Marketable Securities Standard

Published financial statements of companies disclose profits at different stages. Profitability ratios focus on these, and constitute just one category of financial ratios. In the next section we look at profits and profitability ratios. We will look at other financial ratios in separate articles.

Gross, Operating, Pretax and Net Profits

• Gross profit is the surplus generated by sales over cost of goods sold. Cost of goods sold includes direct costs such as materials/merchandise costs, carriage inwards on these, processing costs and production overhead. Efficient materials procurement & handling, and well-designed and executed production processes keep costs low and increase the gross margin.
• Operating profits are arrived at by deducting marketing, administration, depreciation and R&D costs from the gross margin. Companies seek to maximize operating costs through efficient operations and effective marketing.
• Pretax profits are computed by deducting non-operational expenses from operating profits and by adding non-operational revenues to it. It thus accounts for incidental income and expenditure in addition to items related to regular operations.
• Net profits are the profits that remain after tax. Tax burden can be minimized through legal tax avoidance measures. It is this final profit that is available for distribution as dividend or for adding to shareholder equity as retained earnings.

Profit Margin Ratios

Profit margin ratios compare the four levels of profits mentioned in the previous section with the net sales or revenue amount. The ratios are typically converted into percentages for easy understanding.

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