Profitability Ratios (GPM, OPM, NPM)
Commonly used ratios
These ratios are gross profit margin (GPM), operating profit margin (OPM) and net profit margin (NPM).
Other indicators
These measure the profit earned by the company on each rupee of capital invested in it.
These return on capital, return on assets and return on equity.
Here, however, we will discuss the first set of profitability ratios.
Gross profit margin
It is the ratio of the gross profit (sales minus cost of sales) to sales.
Consider a company with Rs 100 as sales and Rs 10 as cost of goods sold.
The gross profit would be Rs 90 (Rs 100–Rs 10) and GPM would be 90 per cent (Rs 90/Rs 100).
A higher GPM compared to others in the same industry indicates either or both of the two possibilities: higher realisation on each unit sold and the ability to source raw materials at a lower cost.
Operating margin
It shows the impact of operating cost on a company’s profitability and is calculated as operating profit divided by sales. A high operating cost affects the OPM.
In the above example, if the operating cost other than the cost of sales is Rs 50, the operating profit would be Rs 40 (Rs 90–Rs 50) and OPM would be 40 per cent.
If OPM increases over time and GPM remain the same, it indicates an improvement in operating efficiency.
Net profit margin
It shows how much a company saves after meeting all its expenses.
So, an NPM of 20 per cent would mean that a company is able to save Rs 20 per Rs 100 sales after meeting all its expenses.
If a company’s NPM increases over time and OPM remains the same, it indicates a reduction in non-operating expenses such as taxes and the interest outgo.
Profitability ratios help you pick the best among various stocks.
The higher the ratio, the better it is. However, ensure that the comparison is made among companies from the same sector as different industries have different levels of profitability.
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