• Tuesday June 2,2020

Cost effectiveness

We explain what profitability is and the types of profitability that are distinguished. In addition, its indicators and its relationship with risk.

Profitability is a fundamental element in economic planning.
  1. What is the profitability?

When we talk about accountability, we refer to the ability of a given investment to yield greater benefits than those invested after waiting for a period of time. It is a fundamental element in economic and financial planning, since it means having made good choices.

There is cost-effectiveness, then, when a significant percentage of the investment capital is received, at a rate considered adequate to project it over time. It will depend on the profit obtained through the investment and, therefore, determine the sustainability of the project or its suitability for partners or investors.

Commonly distinguishes between economic, financial and social profitability:

  • Economic profitability . It has to do with the average benefit of an organization of your company with respect to all the investments you have made. It is usually represented in percentage terms (%), based on the comparison between globally invested and the result obtained: costs and profit.
  • Financial profitability. This term, on the other hand, is used to differentiate from the previous one the benefit that each partner of the company carries, that is, the individual ability to obtain profit from their particular investment. It is a measure closer to investors and owners, and is conceived as the relationship between net profit and net worth of the company.
  • Social profitability. It is used to refer to other types of non-fiscal gain, such as time, prestige or social happiness, which are capitalized in ways other than monetary gain. A project may not be economically profitable but it can be socially profitable.

See also: Financial Statements.

  1. Profitability Indicators

Profitability indicators control the balance of expenses and benefits.

The indicators of profitability (or profitability) in a business or a company are those that serve to determine the effectiveness of the project in the generation of wealth, that is, that allow to control the balance of expenses and benefits, and thus guarantee the return.

The profitability indicators are:

  • Net profit margin . It consists of the relationship between the total sales of the company (operating income) and its net income. This will depend on profitability on assets and equity.
  • Gross profit margin . It consists of the relationship between total sales and gross profit, that is, the remaining percentage of operating income once the cost of sales is discounted.
  • Operational margin . It consists of the relationship between total sales, again, and operating profit, so it measures the performance of operational assets for the development of its corporate purpose.
  • Net return on investment . It serves to evaluate the net profitability (use of assets, financing, taxes, expenses, etc.) originated on the assets of the company.
  • Operational return on investment . Similar to the previous case, but it evaluates the operational profitability instead of the net.
  • Profitability on equity . Evaluate the profitability of the owners of the organization before and after dealing with taxes.
  • Sustainable growth . It aims for the growth of demand to be satisfied with a growth in sales and assets, that is, it is the result of the application of sales, financing, etc. policies. of the company.
  • EBITDA The net cash flow of the company is thus known before taxes and financial expenses are settled.
  1. Profitability and risk

The risk indicator assesses the economic profitability of companies and countries.

The risk of an asset or a company depends on its ability to generate a return, that is, to provide profits and comply with all agreed financial terms, once the expiration date has been reached.

Thus, it is the product of an evaluation of the probability of payments: the greater the possibility of default or breach of contractual terms, the greater the margin of risk assigned.

This indicator is not only used to assess the economic profitability of companies, but also of countries. The risk margin of each entity will depend on the solvency they present with their creditors and the guarantees that are incorporated into the title.

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