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NISM-Series-XV: Research Analyst · Company Analysis - Financial Analysis

Ratio Analysis: Profitability and Return Ratios (ROE, ROCE, ROA)

Updated 11 October 2026 · Fact-checked

Profitability ratios show how much profit a company earns from sales (margins). Return ratios show how much profit it earns on the money invested: ROE on shareholders' equity, ROCE on capital employed, ROA on total assets. Pick the right profit figure, divide by the matching base, then compare with peers and past years.

Understand Ratio Analysis: Profitability and Return Ratios

A company can grow sales and still be a poor business. Profitability ratios test this. They ask how much of each rupee of sales is kept as profit, and how well the company uses the money put into it.

Margin ratios compare profit with sales. Gross margin looks only at the cost of making the product. Operating (EBITDA or EBIT) margin adds operating costs. Net profit margin is the final profit after interest, tax and everything else. A falling margin with rising sales often signals pricing pressure or cost problems.

Return ratios compare profit with capital. ROE measures what shareholders earn on their own money. ROCE measures what the business earns on all long-term capital, both equity and debt, so it is not affected by how the business is financed. ROA measures profit against everything the company owns.

The key idea is matching. If the base includes lenders' money (ROCE, ROA), the profit should be before the lenders' share, i.e. before interest. If the base is only equity (ROE), the profit should be after interest and tax, i.e. the profit available to shareholders.

High debt can lift ROE even when the business is weak, because equity is a small base. That is why ROE is read together with ROCE and leverage. Ratios are meaningful only against peers in the same industry and against the company's own trend.

Key formulas to remember

Gross profit margin
Gross profit ÷ Net sales × 100
Gross profit = Sales − Cost of goods sold.
Operating profit margin
Operating profit (EBIT) ÷ Net sales × 100
EBITDA margin uses EBITDA, which is before depreciation. Read which one the question asks for.
Net profit margin
Profit after tax (PAT) ÷ Net sales × 100
Uses profit after interest and tax.
Return on equity (ROE)
PAT ÷ Average (or closing) shareholders' equity × 100
Use the basis the question states. If none is stated, use the equity figure given.
Return on capital employed (ROCE)
EBIT ÷ Capital employed × 100
Capital employed = Total assets − Current liabilities = Equity + Long-term debt (in the usual treatment).
Return on assets (ROA)
PAT ÷ Total assets × 100
Some texts add back after-tax interest to PAT. Follow the question's definition.

How to solve Ratio Analysis: Profitability and Return Ratios questions

Use this method for any calculation or interpretation question on margins and returns.

  1. 1Read which ratio is asked and note its exact name (gross, operating, net margin, ROE, ROCE, ROA).
  2. 2Pick the matching profit figure: EBIT for ROCE, PAT for ROE, net margin and ROA, gross profit for gross margin.
  3. 3Pick the matching base: net sales for margins, equity for ROE, capital employed for ROCE, total assets for ROA.
  4. 4Check whether the question gives average or closing balances, and use what is given.
  5. 5Compute and express the answer as a percentage, then check it against the options.
  6. 6If it is an interpretation question, compare with the previous year or peers and look for the cause, such as margins, leverage or asset base.
  7. 7Eliminate options that mix a profit figure with the wrong base.

Quickest way: Match profit to base in ten seconds

When to use it: Use for direct calculation questions where all figures are given.

  1. Underline the ratio name and write the profit and base next to it.
  2. Divide and convert to a percentage.
  3. Check the sanity: ROE above ROCE often points to leverage, and net margin is never above gross margin.
  4. Pick the option that matches; do not guess if two options look close, recheck the base.

Common mistakes in Ratio Analysis: Profitability and Return Ratios

  • Using PAT for ROCE

    Students remember PAT as the standard profit figure.

    Fix: ROCE uses EBIT because capital employed includes debt, so profit must be before interest.

  • Using total assets as capital employed

    Both sound like the total size of the business.

    Fix: Capital employed = Total assets − Current liabilities. Subtract current liabilities.

  • Calling a high ROE always good

    Higher return looks better.

    Fix: High debt shrinks equity and can inflate ROE. Check leverage and ROCE before concluding.

  • Dividing margins by assets or equity

    Mixing the margin and return formulas.

    Fix: Margins use net sales as the base. Returns use capital or assets.

  • Ignoring whether EBIT or EBITDA is asked

    Both are called operating profit in casual use.

    Fix: EBITDA is before depreciation, EBIT is after it. Use the one named in the question.

  • Comparing ratios across different industries

    A number seems comparable by itself.

    Fix: Compare only with peers in the same industry and with the company's own history.

Worked examples

Example 1

A company has net sales of ₹500 crore, EBIT of ₹80 crore, interest of ₹20 crore and PAT of ₹45 crore. Shareholders' equity is ₹300 crore. Calculate the net profit margin and ROE.

Show the solution
  1. Net profit margin = PAT ÷ Net sales × 100 = 45 ÷ 500 × 100 = 9%.
  2. ROE = PAT ÷ Equity × 100 = 45 ÷ 300 × 100 = 15%.
  3. EBIT and interest are not needed for these two ratios.

Answer: Net profit margin is 9% and ROE is 15%.

Example 2

A company has EBIT of ₹120 crore, total assets of ₹900 crore and current liabilities of ₹300 crore. Calculate ROCE.

Show the solution
  1. Capital employed = Total assets − Current liabilities = 900 − 300 = ₹600 crore.
  2. ROCE = EBIT ÷ Capital employed × 100 = 120 ÷ 600 × 100 = 20%.

Answer: ROCE is 20%.

Exam tips

  • Most questions test matching: which profit goes with which base. Learn this pairing first.
  • Expect a short interpretation question, such as why ROE rose while ROCE stayed flat. The usual answer is higher leverage.
  • Read the options for traps that use PAT where EBIT is required.
  • Do the arithmetic once and check with the options; NISM-Series-XV has 25% negative marking, so avoid blind guesses.

Practice questions from Company Analysis - Financial Analysis

Ratio Analysis: Profitability and Return Ratios in other exams

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

Ratio Analysis: Profitability and Return Ratios: frequently asked questions

What is the difference between ROE and ROCE?

ROE is PAT divided by shareholders' equity and shows the return to owners. ROCE is EBIT divided by capital employed, which includes debt, and shows the return on all long-term capital. ROE is affected by leverage, ROCE is not directly.

How is capital employed calculated?

It is total assets minus current liabilities. In the usual treatment this equals shareholders' equity plus long-term debt.

Can ROE be higher than ROCE?

Yes. If a company borrows at a cost lower than its return on capital, leverage lifts ROE above ROCE. The risk also rises with debt.

Which profit figure is used for ROA?

The usual definition is PAT divided by total assets. Some texts add back after-tax interest, so follow the formula given in the question.