How to conduct a profitability analysis for your business

Profitability isn’t just about making money. It’s about ensuring your business is built to last.

A profitability analysis helps you evaluate your financial performance and compare it to peers in your industry. By running a profitability analysis, you can assess your company's efficiencies and identify areas for improvement.

We dive deeper into what a profitability analysis is, key ratios for conducting a profitability analysis, and how to measure profitability in five steps.

What is a profitability analysis?

A profitability analysis uses several financial ratios to evaluate a company’s ability to generate a profit from its revenue, assets, and shareholder equity. You can compare the results over different periods or against other businesses in the same market sector to gather insights and make better financial decisions.

Financial planning and analysis (FP&A) managers, business owners, and analysts use profitability analysis to assess various aspects of an income statement and balance sheet, including revenue, expenses, assets, and shareholder equity, to benchmark a company’s performance.

Although some professionals use the term profit analysis to refer to the exercise of reviewing profits, a profitability analysis goes further, evaluating profit relative to revenue, assets, or equity to measure efficiency.

Why is profitability analysis important?

Business owners may feel content in the knowledge that they're making a profit. However, failing to dive into performance details is a mistake.

A profitability analysis allows finance teams to uncover both the efficiencies and inefficiencies of their business operations. It also helps benchmark performance against competitors or industry standards and provides insights you can share with stakeholders and investors.

With the knowledge gained from analysis, you can adjust your financial management strategies to improve decision-making, increase profits, and allocate resources more effectively. It also helps address common challenges, like confusion over which financial metrics to track and how to interpret the data.

Key ratios for profitability analysis

Businesses use several key methods to assess profitability. Each one helps you measure and interpret your company’s ability to generate profit from a different angle, giving you a fuller picture of your financial health.

Profitability ratios, including gross profit margin and net profit margin, are the most common way to measure how much profit your business earns relative to revenue, assets, equity, or operating costs. They provide insight into how efficiently your company converts income into profit.

Gross profit margin

Your gross profit margin tells you the percentage of profits after considering your cost of goods sold (COGS). The formula for calculating gross profit margin is:

Gross profit margin = ((Total revenue – COGS) / Total revenue) * 100

In most cases, your gross profit margin should remain flat from one quarter to the next unless your organization alters its methods for creating products.

Net profit margin

Your net profit margin calculates your company's net profitability after considering all expenses, including interest and taxes. You can calculate your net profit margin with the following formula:

Net profit margin = (Net income / Sales revenue) * 100

Finance teams can improve their net profit margin by cutting expenses or growing revenue.

Operating profit margin

Your operating profit margin measures earnings before interest and taxes (EBIT). It's different from gross profit margin since it considers all operating costs and administrative expenses, not just COGS. The operating profit margin formula is:

Operating profit margin = (Operating profit / Total sales) * 100

Margin per user

Margin per user calculates the company's profits per customer. This metric is especially useful for organizations that follow a subscriber-based business model. To determine your margin per user, apply the following formula:

Margin per user = ((Total revenue – Operating expenses) / Users for period)

Finance teams can further analyze the margin per user by dividing the months included in the financial statements.

Cash flow margin

Your cash flow margin calculates how much income or cash your business generates from its operating activities. In other words, it’s a measure of how well your company translates sales into cash. The formula for calculating cash flow margin is:

Cash flow margin = (Net cash from operating activities / Net sales) * 100

A higher cash flow margin suggests a more efficient business since a greater proportion of your sales is converted into cash.

Return on assets

Return on assets (ROA) refers to the profit generated from your company’s total assets. It compares profit or net income generated from the assets against any cash invested in the company.

The return on assets ratio measures how efficiently a company is using its funding, and in general, the higher the ROA, the better. The formula for calculating return on assets is:

ROA = (Net income / Total assets) * 100

Return on equity

Return on equity (ROE) refers to the amount of returns your company can provide its shareholders. It’s an indicator of how efficiently your company manages its capital invested by shareholders and how much value it’s able to create using it. The formula for calculating return on equity is:

ROE = (Net income / Shareholders' equity)

Investors tend to prefer companies with a higher ROE because it signifies better financial health and higher returns on their investments.

Other methods for assessing profitability

While profitability ratios are the most common way to measure profit, there are other important methods you can use to assess your financial performance from different perspectives. These help you understand not just how much profit you’re earning, but also how well your business is growing, covering its costs, and generating returns on investments.

Revenue ratios

Revenue ratios focus on how much income your business generates, without factoring in expenses. They differ from profit-based ratios because they measure total sales performance rather than what’s left after costs.

Revenue ratios can provide insight into your company’s growth potential and market share. They're also useful when you want to analyze top-line vs. bottom-line growth.

Break-even analysis

Break-even analysis is another important tool for assessing profitability. It shows the point at which your total revenue equals your total costs. It means that your business isn’t making a profit yet, but it also isn’t losing money. To calculate your break-even point, use the formula:

Break-even units = Fixed costs / (Sales price per unit – Variable cost per unit)

Your break-even point is key to business planning because it tells you how much you need to sell just to cover your costs. This helps you set realistic sales targets and price your products appropriately.

Return on investment (ROI)

ROI is a simple but powerful way to measure how effective a specific investment is at generating profit. It compares the gain from an investment to its cost, showing the percentage return you earned. The formula for ROI is:

ROI = (Net profit from investment / Cost of investment) * 100

For example, if you spent $10,000 on a marketing campaign and earned $15,000 in additional revenue, your ROI would be:

(($15,000 – $10,000) / $10,000) * 100 = 50% ROI

ROI helps you evaluate whether an investment is worth it and compare different opportunities to see which one delivers the best return.

How to conduct a profitability analysis, step by step

Here’s how to complete a profitability analysis step by step, including the most commonly used profitability ratios and other key tools:

1. Gather financial statements

To calculate the appropriate metrics for your profitability analysis, you'll need accurate financial statements for your company and (if possible) for a competitor or industry benchmarks for the same period. Be sure to gather:

• Income statement, or profit-and-loss (P&L) statement
• Balance sheet
• Cash flow statement

Before starting, double-check that your data is up to date and consistent across statements. This ensures your analysis reflects an accurate picture of your company’s performance.

2. Calculate key profitability ratios

Now that you know the core profitability ratios, let’s see how to apply them in a real situation. Using the financial details from step 1, calculate the following metrics for your company and compare with a competitor:

Gross profit margin

Company A:

(($1M total revenue – $800k COGS) / ($1M total revenue)) * 100 = 20% gross profit margin

Company B:

(($1.25M total revenue – $950k COGS) / ($1.25M total revenue)) * 100 = 24% gross profit margin

Operating profit margin

Company A:

($100k operating profit / $1M total sales) * 100 = 10% operating profit margin

Company B:

($200k operating profit / $1.25M total sales) * 100 = 16% operating profit margin

Net profit margin

Company A:

($50k net income / $1M sales revenue) * 100 = 5% net profit margin

Company B:

($100k net income / $1.25M sales revenue) * 100 = 8% net profit margin

Margin per user

Company A:

(($1M total revenue – $900k total expenses) / 10k users for period) = $10 margin per user

Company B:

(($1.25M total revenue – $1.05M total expenses) / 12k users for period) = $16.67 margin per user

Return on assets

Company A:

($50k net income / $500k total assets) * 100 = 10% return on assets

Company B:

($100k net income / $750k total assets) * 100 = 13.3% return on assets

3. Perform break-even analysis

Break-even analysis helps you identify the point at which your total revenue equals your total costs—where you’re no longer operating at a loss but not yet making a profit. Use the formula:

Break-even units = Fixed costs / (Sales price per unit – Variable cost per unit)

You can use a spreadsheet or online break-even calculator to simplify the process. Knowing your break-even point helps you set sales targets and evaluate whether your pricing strategy is sustainable.

4. Compare to benchmarks

Next, prepare a spreadsheet detailing the results of your analysis and compare your company’s metrics with a competitor’s or industry benchmarks. The results above show that Company B is more profitable across all metrics. Benchmarking your results helps you understand how your company stacks up against the market and where you might be falling behind.

In our example, Company B’s higher revenue and lower COGS as a percentage of revenue suggest more efficient production and better cost control. Meanwhile, Company A should review its operating expenses and explore ways to reduce overhead without hurting growth.

5. Interpret results and take action

Completing a profitability analysis only matters if you act on the results. Take a close look at what’s driving the differences in profitability and pinpoint specific steps you can take to improve.

For example, you might adjust your pricing or renegotiate supplier contracts to boost margins, cut unnecessary overhead, or focus on attracting more high-value customers to increase margin per user.

These insights can help your FP&A team fine-tune your operating model, allocate resources more efficiently, and plan for sustainable growth.

Common challenges and how to avoid them

A profitability analysis is only useful if the results are accurate and meaningful. But a few common mistakes can lead you astray if you’re not careful. Here are some errors to watch out for and how to avoid them:

• Using incomplete or outdated data: Make sure the income statement, balance sheet, and cash flow statement you’re working with are up-to-date and accurate. Even small errors or missing figures can throw off your calculations.
• Misinterpreting ratios: Profitability ratios only tell part of the story. A strong gross profit margin, for example, might hide high operating costs that eat into net profit. Look at multiple ratios together to get a full picture.
• Ignoring external factors: Market conditions, seasonality, and competitive pressures can all impact profitability. Benchmark your results against industry standards to put your numbers in context.
• Overlooking indirect costs: It’s easy to focus just on direct costs and miss things like administrative overhead or hidden inefficiencies that hurt profit margins. Be thorough when gathering data.

How Ramp transforms profitability analysis from guesswork to precision

Analyzing profitability shouldn't feel like searching for a needle in a haystack. Yet many businesses struggle to get clear visibility into their spending patterns, making it nearly impossible to identify where profits are leaking or which investments actually drive returns. Without real-time data and automated categorization, finance teams waste hours manually sorting through transactions and building reports that are outdated by the time they're finished.

Ramp's expense management platform tackles these challenges head-on with automated expense categorization and real-time reporting. When employees make purchases with Ramp cards, the platform automatically categorizes expenses using merchant data and machine learning, eliminating the manual coding that eats up valuable time. You can see exactly where money flows across departments, projects, and vendors without waiting for month-end reconciliation. This instant visibility means you can spot unusual spending patterns or budget overruns before they impact your bottom line.

The platform's customizable spending controls add another layer of profitability protection. You can set precise limits by category, vendor, or time period, ensuring teams stay within budget while maintaining the flexibility to operate effectively. For instance, you might limit marketing's software subscriptions to $5,000 monthly while allowing higher limits during campaign seasons. These controls prevent surprise expenses that erode margins while giving you data-rich insights into which spending categories deliver the best ROI.

Ramp's accounting integrations streamline the entire financial analysis process by syncing transactions directly with your general ledger. Instead of manually importing and matching transactions, your books stay current automatically, giving you accurate profitability metrics whenever you need them. This real-time financial clarity transforms profitability analysis from a backward-looking exercise into a forward-thinking strategy that drives smarter spending decisions across your organization.

Uncover savings and improve profitability with Ramp

Beyond analysis, Ramp helps you take action on profitability insights. Ramp Intelligence identifies hidden cost-saving opportunities like duplicate subscriptions and unused software licenses that quietly drain your budget.

Ready to see how much you could save? Explore an interactive product tour to discover Ramp's full suite of expense management automation capabilities.