The term profitability refers to the benefits obtained or that can be obtained from an investment made previously. This concept is very important both in business and in investment, since it allows us to know the capacity of a company to remunerate the financial resources used.
Profitability types
It is necessary to basically distinguish between two classes of profitability, such as financial profitability and economic profitability:
Financial profit
This concept of financial profitability encompasses the benefit obtained by the different partners of a business. It is responsible for measuring the ability of a company to generate income from its funds. It refers to the relationship between net profit and net worth of the company. Financial profitability can be improved in several ways:
- Increasing the debt so that the difference between the assets and the own funds
- Increasing the margin
- Reducing the asset or increasing sales
Economic profitability
The definition of economic profitability is the average profit that companies have due to the different investments made. That concept is represented by a percentage. If in a year it obtains a profitability of 20% it implies that for every 100 euros invested it has obtained 20 profits.
The concept of economic profitability deals with comparing the result achieved with the development of the company's activity with the investments made. That result will be even less when having to subtract taxes, expenses and interests.
Each company must adopt the most appropriate methods for its business with the aim of increasing economic profitability. The simplest and most used way is to lower the business costs ordinary and raise the price of products or goods.
The economic profitability is achieved above all from two aspects, the profit margin and the number of sales, so if we are not able to raise the margin, the solution that remains will be to improve sales.