Last reviewed: July 2026.
Profitability ratios assess how effectively a business converts revenue, assets and long-term financing into profit. Return on capital employed (ROCE) is a primary measure because it links operating performance to the capital used to generate that performance.
Ratios should be interpreted through trends, business context, cash flow and the quality of the underlying accounting numbers.
Core profitability ratios
| Ratio | Formula | Primary question |
|---|---|---|
| Gross profit margin | Gross profit ÷ Revenue × 100 | How profitable is direct trading? |
| Operating profit margin | Operating profit ÷ Revenue × 100 | How well are operating costs controlled? |
| ROCE | Profit before financing and income taxes ÷ Capital employed × 100 | What return is generated from long-term capital? |
| Asset turnover | Revenue ÷ Capital employed | How efficiently is capital used to generate revenue? |
| Return on equity | Profit attributable to ordinary owners ÷ Average ordinary equity × 100 | What return is generated for ordinary shareholders? |
ROCE formula
Capital employed is commonly calculated as total equity plus non-current interest-bearing debt, or total assets less current liabilities. The numerator and denominator must be compatible.
Under IFRS 18 terminology, profit before financing and income taxes is often the appropriate numerator.
Worked ROCE example
A company reports profit before financing and income taxes of 240,000 CU, equity of 900,000 CU and non-current debt of 300,000 CU.
ROCE is:
240,000 ÷ 1,200,000 × 100 = 20%
Average versus closing capital
Profit is earned over a period, while capital employed is measured at a date. Average opening and closing capital can improve matching, particularly when major acquisitions, disposals or financing changes occurred.
ROCE decomposition
ROCE can often be analysed as:
Operating profit margin × Asset turnover
This relationship helps identify whether returns changed because of margins, asset use or both. It requires compatible profit definitions.
Gross profit margin
Gross margin reflects selling prices, purchase or production costs, product mix, inventory write-downs and classification. A higher margin can result from improved pricing or from costs being moved below gross profit.
Operating profit margin
Operating margin considers operating overheads as well as gross profit. Analyse marketing, administration, depreciation, employee costs and one-off operating items.
Asset turnover
Asset turnover shows how much revenue is generated per unit of capital employed. A high result may indicate efficient use, but can also result from old fully depreciated assets or underinvestment.
Return on equity
ROE focuses on ordinary shareholders and includes the effects of financing. Higher debt can increase ROE when operating returns exceed borrowing costs, but also increases risk.
Worked decomposition example
Revenue is 2,000,000 CU, profit before financing and income taxes is 200,000 CU and capital employed is 1,000,000 CU.
- Profit margin: 200,000 ÷ 2,000,000 = 10%
- Asset turnover: 2,000,000 ÷ 1,000,000 = 2 times
- ROCE: 10% × 2 = 20%
Effect of IFRS 18
IFRS 18 presents operating profit and profit before financing and income taxes as defined subtotals. When investing income exists, the two amounts can differ, so analysts should select the numerator carefully.
Effect of asset revaluation
A revaluation increases capital employed and can reduce ROCE even when operations do not change. Depreciation may also rise in later periods.
Compare accounting policies and asset ages before benchmarking.
Effect of acquisitions and disposals
A major acquisition may add capital before a full year of profit is earned. A disposal can temporarily improve asset turnover and ROCE by reducing the denominator and recognising a gain.
Profit quality
Review whether profit includes fair value gains, disposal gains, reversals, capitalised costs or unusually low provisions. Compare profit with operating cash flow.
See the profit and cash-flow linkage guide.
Industry comparison
Capital-intensive utilities, software companies and retailers have different normal margins and turnover. Compare entities with similar business models and accounting policies.
Profitability and working capital
Strong margins do not guarantee liquidity. Revenue growth can consume cash through inventory and receivables.
Review inventory turnover days and the cash conversion cycle.
Inflation and replacement cost
Historical carrying amounts can make old asset bases appear unusually efficient. In an inflationary environment, compare accounting ROCE with replacement investment needs and current operating capacity.
Segment profitability
Group-wide ratios can hide profitable and loss-making products, locations or divisions. Segment analysis should use consistent allocations and avoid forcing common costs into misleading unit measures.
Improving profitability responsibly
- improve product and customer mix;
- review pricing and discount discipline;
- reduce waste and process cost;
- use assets more effectively;
- dispose of genuinely surplus assets;
- improve capacity utilisation;
- avoid cutting controls, maintenance or innovation only to improve short-term profit.
Analysis checklist
- define each ratio consistently;
- use average balances where material;
- separate recurring and one-off items;
- consider revaluations and asset age;
- compare with cash flow and liquidity;
- analyse margin and turnover together;
- document limitations and conclusions.
Common mistakes
- using profit after interest with debt plus equity capital;
- using closing capital after a major mid-year acquisition;
- assuming higher ROCE is always operational improvement;
- ignoring old assets and revaluation policy;
- comparing unrelated industries;
- calculating ratios without explaining causes.
Key takeaway
ROCE combines profit margin and asset utilisation. Reliable interpretation requires compatible formulas, trend analysis, asset and financing context, and a comparison with cash generation.
Official learning references: ACCA ratio analysis, ACCA financial statement interpretation, and IFRS 18.