What is a common measure of profitability?

Answer 1

In order to see how to measure profitability, we first have to define the term. Profit is defined as follows:

A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes to the business's owners, who may or may not decide to spend it on the business.

Profit = Total Revenues - Total Expenses

That seems easy but it is not. 99.9999% of companies operate in accounting based system, not cash based system. If they were to operate in a cash based system, you just have to count the amount of money you have, after you pay all your bills. However, things get a little more complicated in an accounting based system.

When you are looking at a company's income statement (also known as Profit and Loss (P&L), Statement of Earnings), you start out with:

Revenue
- Cost of Sales
______________________
Gross Margin
- Total Operating Expenses
______________________
Earnings Before Interest and Taxes (EBIT)
- Interest Expenses
______________________
Earnings Before Taxes (EBT)
- Total Taxes
______________________
Net Income (NI)
- Total Dividends
______________________
Retained Earnings

As you can see, there are many different "Earnings", not including per share terms. Usually people define earnings by one of following:

• Earnings Before Interest and Taxes (EBIT)
• Net Income (NI)
• Earnings Per Share (EPS) = (Net Income - Preferred Dividends) / (# of common shares outstanding)