Businesses should regularly and objectively assess how efficiently they use their resources — namely assets, capital, and products. Such an analysis is important not only for owners but also for investors and creditors. The profitability indicator helps all parties to a transaction understand how stable the business is, how efficiently it operates, and whether it makes sense to invest in it.
What is profitability?
Profitabilityis a relative indicator of the economic efficiency of a business entity, which characterizes the level of profitability or return on resources used (assets, equity, expenses, etc.) over a certain period of time.
In simple terms, profitability is an indicator of how profitably and efficiently a company uses its resources and reflects the ability to generate profit from invested funds.
For detailed calculations, it is important to understand the differences between different profitability indicators, as they focus on different areas of resources.
- Return on sales (ROS) is a financial indicator that allows you to assess how profitable your sales are. If the indicator is high, it means that costs are controlled and profits are growing.
- Return on Assets (ROA) demonstrates how efficiently a company uses all its assets (both owned and borrowed) to generate profit. It provides an indication of how productively investments in property, equipment, inventory, etc. are being utilized.
- Return on Equity (ROE)shows how much profit a company makes for every dollar (or hryvnia) of equity invested by its owners. This indicator is especially important for investors and owners, as it reflects the return on their investment.
How do I calculate return on sales?
To calculate your return on sales (ROS), you need two key figures from your income statement:
1. Net Profit: This is your total profit after deducting all expenses, including cost of goods sold, operating expenses, interest on loans, and taxes.
2. Net Sales or Revenue: This is the total amount of money you make from selling your goods or services over a period of time.
The formula for calculating the return on sales is as follows:
- Example.
Let's say your company received for the month:
- Net profit: 20,000 UAH
- Net income (Revenue): 100,000 UAH
Then the return on sales will be calculated as follows:
ROS=20000/100000×100%=20%
This means that every 1 hryvnia of revenue you earn brings 20 kopecks of net profit.
It's important to remember that return on sales is a relative metric and should be analyzed in the context of your industry, business model, and previous performance. A high ROS usually indicates effective cost management and pricing, while a low ROS may indicate problems with cost, operating expenses, or insufficient sales.
How to calculate the profitability of a specific product?
To calculate the profitability of a particular product, you need to determine the profit generated by selling this particular product and the costs associated with its production and sale. Here are the main steps and the formula:
1. Determine the revenue from the sale of a specific type of product:
This is the total amount of money received from the sale of this product over a certain period of time (for example, a month, quarter, year).
2. Determine its cost price:
Cost includes all direct costs directly related to the production of this particular product, such as:
- The cost of raw materials and supplies used to produce the product.
- Wages and salaries of production workers directly involved in the production of the product.
- Depreciation of equipment used in the production of that product.
- Other direct production costs that can be clearly attributed to the product.
3. Determine the gross profit on the sale of this product:
Gross profit is calculated as the difference between sales revenue and the cost of goods sold:
Gross profit = Sales revenue - Cost of goods sold
4. Determine the operating costs associated with a particular type of product (if possible):
This is a more complex step, as not all operating costs can be easily allocated to a specific product. However, if there are costs that are directly related to the marketing, sales, or service of that particular product, they should be considered.
5. Calculate the net profit from the sale of a specific product (if possible):
Net profit = Gross profit - Operating expenses (related to the product)
6. Calculate the profitability of sales of this product:
There are several ways to calculate the profitability of a product, depending on which profit you use:
- Return on sales based on gross profit
- Cost of sales profitability
- Net profit margin (if operating expenses are included)** Return on sales (if operating expenses are included)
Summary of key points:
- Cost accounting: The most difficult task is to accurately allocate costs to a particular product, especially indirect costs (e.g., administrative, general and administrative). This may require the use of cost allocation methods.
- Analysis period: Determine the time period for which you are calculating profitability (month, quarter, year).
- Comparisons: Compare the profitability of different products in your assortment, as well as the profitability of the same product over different time periods, to track dynamics and identify trends.
Calculating the profitability of a specific product type helps you understand which products are most profitable for your business and make decisions about pricing, assortment, and marketing efforts.
How to take into account seasonality when analyzing product profitability?
To understand how the profitability of a product changes throughout the year, we compare this indicator and visualize it. But in this case, we must not forget about the seasonality of products. So, here's a list of steps to take to get true insights.
1. Compare the same periods.
You should compare profitability not just “month by month,” but by similar periods:
- year to year (for example, March 2024 vs. March 2025)
- by seasons (for example, spring 2024 vs. spring 2025)
- by holiday periods (for example, the week before Easter every year)
This minimizes the impact of seasonal demand.
2. Use seasonal coefficients.
If you have already accumulated sales statistics for several years, you can build a seasonal index:
- calculate the average profitability for each month for several years;
- determine the deviation of each month from the annual average;
- use these coefficients to adjust the profitability.
3. Evaluate profitability in relation to other indicators.
Seasonality often changes:
- costs (e.g., changes in purchase price due to seasonal factors)
- pricing policy (promotions, discounts),
- demand and sales volumes.
Therefore, for a complete analysis, it is important to consider profitability in conjunction with other business metrics.
Conveniently, the analytical system Datawiz has a report Goods Sales, which allows you not only to see the profitability of each product, but also automatically calculates the change in profitability as a percentage compared to the previous period. This makes it possible to quickly assess the dynamics and identify where significant fluctuations occurred - due to seasonality, changes in the purchase price, or adjustments to the margin.
Such analytics saves time and helps to make accurate, informed decisions about the assortment and pricing strategy.
