Accounting ratios are very useful tool to provide information about the financial soundness, strength, position and status of an organization.

**Functional Classification of Accounting Ratios**: The classification of ratios according to the purpose of its computation is known as functional classification. On this basis ratios are classified as follows:

- Profitability Ratios
- Turnover Ratio or Activity Ratio
- Financial Ratio or Solvency Ratio.
- Market Test Ratios

In this blog, we are going to discuss about the Profitability ratios, their formulas & use.

Profitability Ratios measures the overall efficiency of the organization. **Profitability Ratio determined on the basis of investment and sales.**

The income as compared to capital employed indicated the profitability of the firm.

**Main Profitability Ratio** = Operating profit /Operating Capital Employed * 100

**Profitability in relation to investments **

**1. ****Return on Investment: **It defines the earning of the company as compared to its investment.

**Return on Investment** = Net Operating Profit /Capital Employed * 100

- Operating profit means profit before interest & tax
- Capital Employed = Share Capital + Reserve and surplus + long term loans – Non operating assets – fictitious assets

**2. ****Return on Shareholders’ Fund**: It determines the profitability of the company from the shareholders’ point of view.

** Return on Shareholders’ Fund**= Net Profit after interest and tax / Shareholders’ Fund * 100

**3. ****Return on Assets**: In this ratio profitability is measured in terms of the relationship between net profits and assets.

**Return on Assets** = Net profit after tax /Total assets * 100

*Profitability in relation to sales *

**1.****Gross profit Ratio: **It defines the relationship of gross profit to net sales. This ratio determines the general profitability.

**Gross profit Ratio = **Gross profit/Net sales * 100

**2.Net Profit Ratio**: It represents the net margin earned in a sale of Rs 100.

**Net Profit Ratio = **Operating profit /sales * 100

**3.Operating Ratio**: It is the ratio of operating expenses (materials used, labour, factory overheads, office and selling expenses) to sales. This ratio indicate whether the cost is high or low in comparison to sales

- Material cost ratio = Material consumed /sales * 100
- Labour Cost ratio = Labour cost /sales * 100
- Administrative expenses ratio = Administrative expenses / Sales * 100