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Corporate Accounting and Financial Management · Financial Statement Analysis

Profitability and Activity Ratios: Formulas and Numericals

Updated 11 October 2026 · Fact-checked

Profitability ratios measure how much profit a business earns on sales or on capital, such as gross margin, net margin, ROCE and ROE. Activity ratios measure how fast it uses assets, such as stock, debtors and creditors turnover. Write the formula, compute the averages, substitute carefully, and add a one-line comment.

Understand Profitability and Activity Ratios

Ratios turn raw figures into comparisons. A profit of ₹10 lakh means little alone. Against sales of ₹1 crore it is a 10% margin. That is the idea behind this topic.

Profitability ratios show how well the business earns. Margin ratios compare profit with sales. Return ratios compare profit with the money invested, either total long-term capital (ROCE) or the owners' money (ROE).

Activity ratios (also called turnover ratios) show how efficiently the business uses its assets. Stock turnover tells you how many times stock is sold and replaced in a year. Debtors turnover tells you how fast customers pay. Creditors turnover tells you how fast you pay suppliers. Asset turnover tells you how much sales each rupee of assets produces.

The two groups are linked. A business can earn a high return by keeping margins high, by turning assets fast, or both. A fast turnover with thin margin is common in trading. A slow turnover with high margin is common in heavy industry.

In the exam, you are rarely asked to compute alone. You must also say what the ratio shows. A higher stock turnover usually means better sales or tighter stock control. A longer debtors collection period means cash is stuck with customers.

Key rules to remember

Gross profit ratio
Gross profit ÷ Net sales × 100
Gross profit = Net sales − Cost of goods sold. Net sales means sales less returns.
Net profit ratio
Net profit ÷ Net sales × 100
Use the profit figure the question specifies (before or after tax). If unclear, state your assumption.
Operating profit ratio
Operating profit ÷ Net sales × 100
Operating profit = Net sales − COGS − operating expenses. Exclude non-operating items such as interest and gains on investments.
Return on capital employed (ROCE)
EBIT ÷ Capital employed × 100
Capital employed = Equity share capital + Reserves + Preference capital + Long-term debt. It also equals Fixed assets + Working capital. Use average capital employed if opening figures are given.
Return on equity (ROE)
(Net profit after tax − Preference dividend) ÷ Equity shareholders' funds × 100
Equity shareholders' funds = Equity share capital + Reserves and surplus. Use the average if opening and closing are given.
Stock turnover ratio
Cost of goods sold ÷ Average stock
Average stock = (Opening stock + Closing stock) ÷ 2. Holding period in days = 365 ÷ ratio.
Debtors turnover ratio
Net credit sales ÷ Average trade receivables
Receivables include bills receivable. Collection period = 365 ÷ ratio (or 12 months ÷ ratio).
Creditors turnover ratio
Net credit purchases ÷ Average trade payables
Payables include bills payable. Payment period = 365 ÷ ratio.
Fixed asset and total asset turnover
Net sales ÷ Net fixed assets; Net sales ÷ Total assets
Working capital turnover = Net sales ÷ Working capital.

How to solve Profitability and Activity Ratios questions

Use the same routine for every ratio question. It keeps your working visible and protects method marks.

  1. 1Read the question and list which ratios are asked. Note whether sales, purchases or profit are given as credit or total.
  2. 2Write each formula in full before substituting.
  3. 3Find the missing inputs first: gross profit, COGS, EBIT, capital employed, average balances.
  4. 4Use averages for stock, debtors and creditors when opening and closing figures are given. Otherwise use the closing figure and say so.
  5. 5Substitute and calculate. Show the figures so marks are earned even if arithmetic slips.
  6. 6Keep the unit clear: percentage for profitability, times or days for activity ratios.
  7. 7Write a one- or two-line interpretation for each ratio.
  8. 8Check that the answers are consistent, for example that gross profit is higher than net profit.

Quickest way: Build-up then ratio

When to use it: Use when the question gives a trading account or balance sheet in pieces and asks for several ratios.

  1. Rebuild the trading and profit and loss figures first: sales, COGS, gross profit, EBIT, net profit.
  2. Rebuild the balance sheet figures: capital employed, equity funds, average stock, debtors, creditors.
  3. Compute the profitability ratios in one block, then the turnover ratios in another.
  4. Convert turnover into days only if the question asks for it.
  5. Add a short comment next to each answer.

Common mistakes in Profitability and Activity Ratios

  • Using total sales instead of net credit sales for debtors turnover.

    Students pick the first sales figure in the question.

    Fix: Check for cash sales and returns. Use credit sales less returns. If no split is given, use total sales and state your assumption.

  • Using sales instead of cost of goods sold for stock turnover.

    Sales is the figure students see most often.

    Fix: Stock is valued at cost, so divide COGS by average stock. Use sales only if the question says so.

  • Taking closing capital employed when averages are given.

    Students rush to the balance sheet.

    Fix: If opening and closing figures are given, average them for ROCE, ROE and turnover ratios unless told otherwise.

  • Deducting interest before computing ROCE.

    Students confuse ROCE with ROE or net margin.

    Fix: ROCE uses EBIT because capital employed includes debt. Use profit after interest and tax only for ROE.

  • Forgetting to deduct preference dividend in ROE.

    Students use net profit directly.

    Fix: ROE is the return to equity holders, so subtract preference dividend and use equity funds in the denominator.

  • Giving a number with no comment.

    Students treat it as a pure calculation.

    Fix: Add one line on what the figure means, such as a longer collection period meaning cash is tied up.

Worked examples

Example 1

A company has net sales of ₹8,00,000, cost of goods sold ₹6,00,000, operating expenses ₹80,000, interest ₹20,000 and tax ₹30,000. Its capital employed is ₹10,00,000 and equity shareholders' funds are ₹6,00,000. There is no preference capital. Calculate gross profit ratio, net profit ratio, ROCE and ROE.

Show the solution
  1. Gross profit = 8,00,000 − 6,00,000 = ₹2,00,000.
  2. Gross profit ratio = 2,00,000 ÷ 8,00,000 × 100 = 25%.
  3. EBIT = 2,00,000 − 80,000 = ₹1,20,000.
  4. Profit before tax = 1,20,000 − 20,000 = ₹1,00,000.
  5. Net profit = 1,00,000 − 30,000 = ₹70,000.
  6. Net profit ratio = 70,000 ÷ 8,00,000 × 100 = 8.75%.
  7. ROCE = 1,20,000 ÷ 10,00,000 × 100 = 12%.
  8. ROE = 70,000 ÷ 6,00,000 × 100 = 11.67% (approx).

Answer: Gross profit ratio 25%; net profit ratio 8.75%; ROCE 12%; ROE about 11.67%. The business earns 12% on all long-term capital and about 11.67% for its owners after interest and tax.

Example 2

From the following, calculate stock turnover, debtors turnover and creditors turnover with the period in days (take 365 days). Opening stock ₹90,000; closing stock ₹1,10,000; COGS ₹8,00,000; opening debtors ₹1,00,000; closing debtors ₹1,40,000; net credit sales ₹9,60,000; opening creditors ₹60,000; closing creditors ₹80,000; net credit purchases ₹7,00,000.

Show the solution
  1. Average stock = (90,000 + 1,10,000) ÷ 2 = ₹1,00,000.
  2. Stock turnover = 8,00,000 ÷ 1,00,000 = 8 times.
  3. Stock holding period = 365 ÷ 8 = 45.6 days (approx).
  4. Average debtors = (1,00,000 + 1,40,000) ÷ 2 = ₹1,20,000.
  5. Debtors turnover = 9,60,000 ÷ 1,20,000 = 8 times.
  6. Collection period = 365 ÷ 8 = 45.6 days (approx).
  7. Average creditors = (60,000 + 80,000) ÷ 2 = ₹70,000.
  8. Creditors turnover = 7,00,000 ÷ 70,000 = 10 times.
  9. Payment period = 365 ÷ 10 = 36.5 days.

Answer: Stock turnover 8 times (about 45.6 days); debtors turnover 8 times (about 45.6 days); creditors turnover 10 times (36.5 days). The firm pays suppliers faster than it collects from customers, so it must fund the gap from other sources.

Exam tips

  • Write the formula before every calculation. Examiners award marks for the correct formula even when arithmetic goes wrong.
  • State your assumption when the question does not split cash and credit sales or purchases.
  • Show how you derived EBIT, capital employed and average balances. These are the usual hidden steps.
  • Add a short interpretation line. Many answers lose marks by giving only a number.
  • Check whether the question asks for days or months, and use the period it specifies.

Practice questions from Financial Statement Analysis

Profitability and Activity 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 and Activity Ratios: frequently asked questions

What is the difference between ROCE and ROE?

ROCE measures return on all long-term capital, using EBIT over capital employed. ROE measures return to equity shareholders only, using profit after tax and preference dividend over equity funds. ROCE ignores how the business is financed, while ROE reflects the effect of debt.

Should I use average or closing balances for turnover ratios?

Use average balances when opening and closing figures are both given, because they represent the whole year better. If only the closing figure is given, use it and state that you have done so.

Does a higher stock turnover ratio always mean better performance?

Not always. A high ratio usually shows quick sales and good control, but it can also mean stock is too low and sales may be lost. Compare it with past years and with similar businesses.

How do I convert a turnover ratio into days?

Divide the number of days in the year by the ratio, using 365 unless the question says 360 or months. For example, a debtors turnover of 8 gives a collection period of about 45.6 days.