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Financial Management and Business Data Analytics · Financial Ratio Analysis

Profitability Ratios for CMA Intermediate Explained

Updated 10 October 2026 · Fact-checked

Profitability ratios measure how well a business earns profit from its sales and from the money invested in it. Margin ratios divide a profit figure by sales. Return ratios (ROCE, ROE) divide profit by capital. EPS divides earnings by equity shares. Pick the right profit and the right capital figure, then divide and interpret.

Understand Profitability Ratios

A profitability ratio compares a profit figure with a base. The base is either sales or the capital invested. This tells you how much profit the business makes for every ₹100 of sales, or for every ₹100 of money put in.

Margin ratios use sales as the base. Gross profit ratio shows how much is left after direct costs. Operating profit ratio shows the result after operating expenses. Net profit ratio shows what remains after all expenses, interest and tax. A falling gross margin points to rising material cost or lower selling prices. A falling net margin with a steady gross margin points to higher overheads, interest or tax.

Return ratios use investment as the base. Return on capital employed (ROCE) looks at all long-term funds, whether from owners or lenders, so the profit used is before interest and tax. Return on equity (ROE) looks only at shareholders' money, so the profit used is after interest, tax and preference dividend. Return on investment (ROI) is often used as a general term. In many books ROI means the same as ROCE. Always state your definition in the answer.

Earnings per share (EPS) shows the profit that belongs to each equity share. It is used by investors and feeds into market ratios such as the price-earnings ratio.

The key rule is to match the profit to the base. Profit before interest goes with total capital. Profit after interest and preference dividend goes with equity only.

Key rules to remember

Gross profit ratio
Gross profit ÷ Net sales × 100
Net sales means sales less returns. Gross profit = Net sales − Cost of goods sold.
Operating profit ratio
Operating profit ÷ Net sales × 100
Operating profit = Gross profit − Operating expenses. Exclude non-operating income and interest.
Net profit ratio
Net profit after tax ÷ Net sales × 100
Some questions ask for the ratio before tax. Read the wording.
Capital employed
Equity share capital + Preference share capital + Reserves and surplus + Long-term debt (or Total assets − Current liabilities)
Both routes give the same figure if non-trade investments and fictitious assets are treated alike. Follow the question's instruction.
Return on capital employed (ROCE)
EBIT ÷ Capital employed × 100
EBIT is earnings before interest and tax. Some questions use closing capital, others average capital.
Return on equity (ROE)
(Net profit after tax − Preference dividend) ÷ Equity shareholders' funds × 100
Equity shareholders' funds = Equity share capital + Reserves and surplus.
Earnings per share (EPS)
(Net profit after tax − Preference dividend) ÷ Number of equity shares
Use the weighted average number of shares if shares changed during the year.

How to solve Profitability Ratios questions

Use this method for any profitability ratio question, whether the data is given directly or must be pulled from statements.

  1. 1Read which ratio is asked and note its exact definition, including whether it is before or after tax.
  2. 2List the data given and identify the profit figure needed: gross profit, operating profit, EBIT, net profit or earnings for equity.
  3. 3Work out any missing profit figure from the statement of profit and loss, adjusting for interest, tax and preference dividend.
  4. 4Identify the base: net sales, capital employed, equity shareholders' funds or number of shares. Compute it separately and show the working.
  5. 5Check whether the question wants closing or average balances. If it gives opening and closing figures, use the average unless told otherwise.
  6. 6Divide, multiply by 100 for percentage ratios, and round as asked.
  7. 7Write one line of interpretation, such as whether profitability is improving or what caused the change.

Quickest way: Margin-first, then capital

When to use it: Use this for MCQs and for the opening part of a long numerical, when time is short.

  1. Convert everything to sales = 100 if percentages are given, so margins come out directly.
  2. For ROCE, take EBIT. For ROE, take profit after tax less preference dividend. Do not mix them.
  3. Compute the base in one line: for ROE, add equity capital and reserves only.
  4. Eliminate options quickly: normally, an after-tax ratio will be lower than the before-tax ratio.
  5. Check the answer for sense: net margin must be below gross margin. ROCE and ROE are not directly comparable because ROCE is before tax. ROE exceeds the post-tax ROCE only when the cost of borrowing is below the return earned on capital employed.

Common mistakes in Profitability Ratios

  • Using net profit instead of EBIT in ROCE

    Students remember net profit as the main profit figure.

    Fix: ROCE uses funds from all long-term providers, so use profit before interest and tax.

  • Including preference share capital in equity for ROE

    Both are called share capital.

    Fix: For ROE, deduct preference dividend from profit and leave preference capital out of the base.

  • Dividing by gross sales instead of net sales

    The question gives sales and returns separately and students ignore returns.

    Fix: Subtract sales returns first and use net sales as the base.

  • Forgetting to average capital when opening and closing figures are given

    Students use whichever figure is handy.

    Fix: Use the average when both are provided and the question does not say otherwise. Write the assumption.

  • Treating ROI and ROE as the same

    Both are called returns.

    Fix: ROI (as ROCE) covers all long-term capital using EBIT. ROE covers only owners' funds using profit after tax.

  • Leaving out interpretation

    Students stop after the number.

    Fix: Add one sentence on the trend or cause. Written answers earn marks for it.

Worked examples

Example 1

Net sales ₹10,00,000; cost of goods sold ₹6,50,000; operating expenses ₹1,50,000; interest ₹40,000; tax ₹30,000. Calculate the gross profit ratio, operating profit ratio and net profit ratio.

Show the solution
  1. Gross profit = 10,00,000 − 6,50,000 = ₹3,50,000.
  2. Gross profit ratio = 3,50,000 ÷ 10,00,000 × 100 = 35%.
  3. Operating profit = 3,50,000 − 1,50,000 = ₹2,00,000.
  4. Operating profit ratio = 2,00,000 ÷ 10,00,000 × 100 = 20%.
  5. Profit before tax = 2,00,000 − 40,000 = ₹1,60,000.
  6. Net profit after tax = 1,60,000 − 30,000 = ₹1,30,000.
  7. Net profit ratio = 1,30,000 ÷ 10,00,000 × 100 = 13%.

Answer: Gross profit ratio 35%, operating profit ratio 20%, net profit ratio 13%. Of every ₹100 of sales, ₹22 goes to overheads and interest-tax items after gross profit, leaving ₹13.

Example 2

A company has equity share capital ₹8,00,000 (80,000 shares of ₹10), 10% preference share capital ₹2,00,000, reserves ₹4,00,000 and 12% long-term debentures ₹6,00,000. Profit before interest and tax is ₹4,20,000. Tax rate is 25%. Calculate ROCE, ROE and EPS using closing balances.

Show the solution
  1. Capital employed = 8,00,000 + 2,00,000 + 4,00,000 + 6,00,000 = ₹20,00,000.
  2. ROCE = 4,20,000 ÷ 20,00,000 × 100 = 21%.
  3. Debenture interest = 12% × 6,00,000 = ₹72,000.
  4. Profit before tax = 4,20,000 − 72,000 = ₹3,48,000.
  5. Tax = 25% × 3,48,000 = ₹87,000. Profit after tax = ₹2,61,000.
  6. Preference dividend = 10% × 2,00,000 = ₹20,000. Earnings for equity = 2,61,000 − 20,000 = ₹2,41,000.
  7. Equity shareholders' funds = 8,00,000 + 4,00,000 = ₹12,00,000.
  8. ROE = 2,41,000 ÷ 12,00,000 × 100 = 20.08% (approximately).
  9. EPS = 2,41,000 ÷ 80,000 = ₹3.01 (approximately).

Answer: ROCE is 21%, ROE is about 20.08% and EPS is about ₹3.01. ROE (20.08%) is slightly below ROCE (21%) mainly because ROCE is before tax, whereas ROE is after tax and preference dividend. Debt at 12% is cheaper than the 21% return, so leverage is favourable.

Exam tips

  • In MCQs, the trap is usually the profit figure. Check whether the question asks for before or after interest and tax.
  • In written answers, show the capital employed or equity funds working as a separate line. Step marks are given for it.
  • When the question gives opening and closing balances, state your assumption on average or closing capital.
  • Add a short comment on each ratio. Say what the change tells the management.
  • Practise reverse problems where the ratio is given and you must find profit or sales.

Practice questions from Financial Ratio Analysis

Profitability Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Profitability Ratios: frequently asked questions

What is the difference between ROI and ROE?

ROI, used as ROCE, measures return on all long-term funds using profit before interest and tax. ROE measures return on equity shareholders' funds using profit after tax and preference dividend. ROE reflects the effect of borrowing, while ROCE does not.

How do you calculate return on capital employed?

Divide EBIT by capital employed and multiply by 100. Capital employed is equity, preference capital, reserves and long-term debt, or total assets less current liabilities. Use average capital if opening and closing figures are given.

What is the formula for gross profit ratio and net profit ratio?

Gross profit ratio is gross profit divided by net sales, times 100. Net profit ratio is net profit after tax divided by net sales, times 100. Both use net sales, which is sales less returns.

Is EPS a profitability ratio?

Yes. EPS shows the earnings available to each equity share. It is calculated after deducting preference dividend from net profit and dividing by the number of equity shares.