What do profitability ratios measure and what is their significance?
Profitability ratios measure the extent to which a company's resources are being used efficiently. Every return ratio is a measure of the relationship between the income earned and the investment made in the company by investors, and long- and short-term creditors. Investors earn a return through the receipt of dividends and appreciation of the market value of their stock. Dividends and market price of shares are both related to the profits generated by companies. Since they are the source of debt-servicing payments, profits are also of concern to creditors. Managers also have a vested interest in profits. Bonuses, promotions, and salary increases are often tied to reported profits. Profitability ratios, therefore, are given particular attention by both internal and external users of financial statements.
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