CO—100
Kirsten Capunay
June 10, 2025
Profitability is one of the most critical indicators of a business’s financial health. It not only reveals how much revenue you’re bringing in, but how efficiently you’re converting that income into profit. For small business owners, understanding profitability is essential for making informed decisions, attracting investment, and sustaining long-term growth.
Here’s why profitability matters—and how you can measure it effectively.
What is profitability?
Profitability is the ratio between a business’s income and its expenses. Leaders can use this data to determine their business’s profitability through a cash flow statement, which details a business’s income and expenses during a particular accounting period.
To measure future profitability, a business may use a pro forma statement, which measures income and expenses for an upcoming accounting period. Some businesses may generate project-specific income or cash flow statements to determine the profitability of a particular business change or upcoming contract.
What is the difference between profitability and profit?
While often used interchangeably, profit and profitability are two distinct financial concepts. Profit is an absolute figure—how much your business earns after expenses, typically reported as gross, operating, or net profit. Profitability, on the other hand, measures efficiency, showing how well your business generates profit relative to revenue, assets, or equity. In short, profit reflects how much you earn, while profitability reveals how efficiently you earn. It’s also important to note that profit is not the same as cash flow.
When should a business assess its profitability?
Profitability analysis should be part of ongoing financial planning to support smart decisions and long-term success. Key times to assess profitability include:
- At the end of the fiscal year: Reviewing profitability annually provides a clear picture of overall performance and helps shape next year’s financial strategy. It is also a key part of updating your financial plan.
- At quarterly check-ins: Regular quarterly reviews help you track progress toward short-term goals, adjust spending, and make timely decisions around growth opportunities.
- When considering a major business change: Launching a new product, changing pricing models, or entering new markets are all moments that warrant a profitability analysis to evaluate impact and guide next steps. Profitability analysis can model what-if scenarios for each of these events.
- During financial challenges: If your business is experiencing declining margins or cash flow issues, a profitability review can pinpoint where adjustments are needed to regain stability.
There are a number of helpful tools and resources to assist with this, including several AI financial planning tools.
Ways to measure profitability
Businesses can measure how profitable they are with a few different types of financial calculations.
Gross profit margin ratio
A gross profit margin ratio analyzes a business’s money flow. To calculate gross profit ratio, first subtract the cost of goods sold (COGS) from net sales. Then divide your gross profit by net sales and multiply that number by 100.
Business managers and owners should keep a close eye on their gross profit margin ratio to ensure it stays stable over time. The ratio should only fluctuate when pricing policies or the price of goods change.
Operating profit margin ratio
An operating profit margin ratio illustrates a business’s earning potential from its current operations. You can calculate your operating profit margin ratio by dividing operating income by net sales, then multiplying that number by 100.
A healthy operating profit margin ratio is one that increases from one accounting period to the next. Businesses use this profitability measurement to calculate their competitive position within an industry.
Net profit margin ratio
The net profit margin ratio measures how much net income a business generates from its total revenue, indicating overall profitability. It helps evaluate efficiency and compare performance over time or against competitors. To calculate, divide net income by net sales, then multiply by 100.
Each industry has a different average net profit margin ratio, so business owners should compare their business’s net profit margin ratio to the industry average to assess yearly performance. A net profit margin is different from an operating profit margin ratio because it accounts for earnings after taxes.
Break-even analysis
A break-even analysis involves determining the point at which a business’s revenues equal expenses. To calculate, a business will need to determine its fixed expenses, variable expenses, and sales. A variable expense is an expense that fluctuates based on sales numbers. The break-even point is when sales equal fixed expenses plus variable expenses.
The break-even point can be expressed in either dollar amounts or units sold and is useful in determining how your business will react when sales slump. This method is incredibly valuable when planning for a business’s future.
Return on assets
A return on assets measurement demonstrates the comparison between assets and revenue. The higher the number, the more efficient the business. To calculate your return on assets, divide net income before taxes by total assets, then multiply that number by 100. A separate, but important, asset cost consideration is asset amortization.
Return on investment
Return on investment allows a business owner to determine if the financial benefit of a project or investment is worth the initial and ongoing expenses. If you will ultimately spend more money than you’ll earn, the venture may not be worth it. To determine a business’s return on investment, divide net profit before taxes by net worth.
No matter which metrics you use to determine your overall profitability, it’s essential to be consistent about tracking your business’s financial performance and health. The sooner you can identify potential problems and negative trends, the sooner you can take action to get back on track.
Profitability benchmarks by industry
Profitability benchmarks can vary significantly across industries. For example, industries like banking and oil show strong margins, while grocery retail and real estate often face tighter or negative margins.
As mentioned, a common benchmark is net profit margin, which shows how much profit a company makes per dollar of revenue after expenses. According to data from Vena Solutions, here are some average net profit margins by industry:
- Banks (Money Center): 30.89%.
- Oil and Gas (Production and Exploration): 28.26%.
- Investments and Asset Management: 19.82%.
- Computers/Peripherals: 17.47%.
- Drugs (Pharmaceutical): 15.20%.
- Retail (Grocery and Food): 1.96%.
- Real Estate Development: -16.35%.
Comparing your margin to industry benchmarks helps identify opportunities for improvement and set realistic expectations for profitability.
How to improve profitability ratios
Improving your profitability ratios involves making strategic adjustments to both revenue generation and cost control. Here are some proven ways to boost your bottom line:
- Review and reduce unnecessary expenses: Regularly audit your spending to identify and cut costs that don’t add value. This may involve renegotiating vendor contracts or eliminating redundant services. Include both direct and indirect costs in your review.
- Raise prices strategically: If your products or services are underpriced, consider adjusting pricing based on market research and customer value perception. Even small increases can significantly improve profit margins.
- Improve operational efficiency: Streamlining workflows and reducing waste—whether in labor, materials, or time—can enhance productivity without increasing costs. This directly impacts profitability ratios.
- Focus on high-margin products or services: Prioritize offerings that deliver the greatest return. Evaluate your product mix and consider phasing out low-margin options.
- Increase customer retention: Retaining existing customers often costs less than acquiring new ones. Invest in customer service, loyalty programs, and ongoing engagement to encourage repeat business.
Cory Parker contributed to this article.