# Financial Ratios Related To Sales And Internal Profitability Ratio

Financial ratios help external stakeholders, and enterprise managers know how well or poorly a business is performing and pinpoint areas that could do with improvement. Companies can also compare themselves to the competition or to diverse companies in other industries. Size need not be an issue since ratios standardize accounting relationships to provide management with a raw reckoning of financial status and trends.

To better categorize them, financial ratios are generally divided into seven principal classes:

• LIQUIDITY RATIOS,

• ACTIVITY RATIOS,

• LEVERAGE/CAPITAL STRUCTURE RATIOS,

• COVERAGE RATIOS,

• PROFITABILITY RATIOS,

• MARKET PROSPECTS RATIOS, AND

• EARNINGS QUALITY

LIQUIDITY RATIOS

Current Ratio gauges the firm’s

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There are two types of profitability ratios: internal Profitability ratios related to Sales and external Profitability ratios related to investor objectives.

Profitability Ratios Related to Sales

A firm generating substantial profits per dollar of sales can securely meet operating expenses and provide higher returns to investors. The relationship between profit and sales is measured by profitability ratios.

We will use two profitability ratios: Gross Profit Margin and Net Profit Margin.

Gross Profit Margin measures the relationship between gross profit and sales.

Gross Profit Margin is calculated:

Gross Profit Margin = Gross Profit/Net sales * 100

This ratio shows profits after manufacturing costs have been met. It measures both production efficiency as well as pricing.

Net Profit Margin is computed using the following formula:

Net profit / Net sales

This ratio shows the net earnings as a percentage of net sales. It measures the overall efficiency of production, administration, selling, financing, pricing and tax strategy. When considered jointly, gross and net profit margin ratios provide understanding of the cost and profit structure of your