Profitability measures the ability of an entity or project to generate profits. Profit is often associated with the amount of money generated. So, when successfully increasing profits, it means companies can make more money, even though the two are not always equal in accrual-based accounting.
When a company is profitable, that means revenue exceeds costs. The company’s profit measures include gross profit, operating profit, EBIT, EBITDA, EBIAT, and net income. When these measures are positive, the company makes a profit because it has a total revenue that is greater than costs. But, once again, remember, profit is not the same as money (cash) in accrual-based accounting.
Furthermore, we can also measure profitability using several profitability ratios, both related to profit return or profit margin. We calculate profit return by comparing net income with some components of the balance sheet, such as total assets, total equity, and invested capital. Meanwhile, when we calculate profit margin, we divide various measures of profit, such as gross profit, operating profit, EBIT, EBITDA, and net income to total revenue.
Profitability provides valuable insights. When companies are profitable, they can make money. That way, they can pay dividends and debt. Investors analyze the company’s profitability carefully because it affects dividends and stock price.
