Key Financial Ratios: Profitability and Efficiency

Raw financial numbers are hard to compare across companies. A company with 100 crore in profit sounds bigger than one with 50 crore, but if the first company has 10,000 crore in equity and the second has 200 crore, the second is actually more profitable per rupee invested. Ratios allow apples-to-apples comparisons.

Return on Equity (ROE)

ROE = Net Profit / Shareholders' Equity. It tells you how much profit a company generated for every rupee of shareholder money invested. A company with an ROE of 20% is generating 20 paise of profit per rupee of equity—better than a company with an ROE of 10%. Over time, companies with high ROE tend to create more wealth for shareholders. The best businesses have ROE above 15-20%.

Return on Assets (ROA)

ROA = Net Profit / Total Assets. It measures how efficiently a company uses all its assets (whether financed by debt or equity) to generate profit. A company with an ROA of 8% is more efficient than one with an ROA of 4%. Service businesses (like consulting) often have higher ROAs because they need fewer assets. Capital-intensive businesses (like steel mills) have lower ROAs because they need large asset bases.

Profit Margins

Gross margin = Gross Profit / Revenue. Operating margin = Operating Profit / Revenue. Net margin = Net Profit / Revenue. These show what percentage of every rupee of revenue becomes profit at different stages. A company with a 50% gross margin but a 5% net margin is spending a lot on operating expenses. Trends in margins matter more than absolute levels; if a company's margins are contracting, something might be wrong.

• High ROE = the company is deploying capital efficiently.
• Consistent profitability matters more than one-time spikes.
• Growing profit is good; growing profit margin is better.
• Compare ratios within the same industry; different industries have different normal levels.