Definition
Profitability analysis is used by business leaders to identify various ways of optimizing company profitability across areas like products, projects, or plans. It involves a systematic analysis of profits generated from various revenue streams of the company.Profitability analysis is often a part of enterprise resource planning (ERP). Simply put, this process analyzes the costs and revenues of a company (or unit or product) to further determine whether the company as a whole or its units or products/services are profitable.
Example
Profitability analysis allows businesses to get an all-encompassing picture of the company’s profits, the ways that it derives profits, profitability ratios, and more. Some of the top ratios that form part of profitability analysis are:a. gross profit marginb. net profit marginc. return on equityd. return on capital employedThese help companies understand how well they are using the available assets, the extent of revenue they can generate against the costs, the company's ability to convert sales into profits, etc.
Why it matters
Profitability analysis is crucial for any business and is important for the survival of the business. Profitability analysis can aid companies in maximizing profits and is especially useful for growing companies in identifying growth opportunities. Profitability analysis also helps company management look at the company-wide performance to further implement the right growth strategies.