Often there are economic concepts that can get out of hand, or confuse with others that, although they seem the same, in reality they have nothing to do with it. That is what happens with economic profitability.
This term is very important for companies or businesses, since it can indicate in a certain way the health that that company has. So if you want learn more about economic profitability, we invite you to read what we have prepared for you.
What is economic profitability?
Economic profitability is a concept that is closely related to companies. In this case, it is also known as ROI, the acronym for Return on Investmet. It refers to profit that a company or business obtains for having invested. In other words, we are talking about the ability of a company to, through the investments it makes, obtain a profit without the need to request financing.
Now, you must bear in mind that this benefit is obtained before deducting interest and taxes, in such a way that the final benefit may be less, or even not be. That is why it is important to take into account this concept, but also others related to it that offer more information.
To calculate the economic profitability, the following formula is used:
Economic profitability = (BAII / Total assets) x 100
In this case, the BAII is the gross profit, before applying interest and taxes, that is, what the company obtains before deducting expenses, taxes and interests. And Total assets are all the assets that a company has, not just its own.
Economic and financial profitability
Although many may consider that economic and financial profitability is the same, the truth is that they are two completely different terms.
For this reason, we explain the two concepts to you so that you realize what the differences between them are.
As we have said before, the economic return is the "gross" benefits that are obtained after an investment without any financing involved.
For its part, financial profitability, It is also known by its acronym ROE, which stands for Return on Equity. We are talking about an indicator that what it does is measure the net profit with the funds and capital of a company or business. In other words, it seeks to measure the viability of the company towards its partners, since what it tries is to know what each person earns based on the funds and capital of the same.
According to the above, the main differences between economic and financial profitability would be the following:
In the economic profitability all assets are taken into account, that is to say, all the resources of the company, own or other people's. However, in the case of financial profitability, only own resources prevail.
There may be a disparity between the two returns. That is, for example, the economic profitability is positive while the financial profitability results in a negative figure. It is not that the accounts are wrong, but it does have to do with the above.
If we take into account the formulas, we talk about the ROI being calculated differently from the ROE. Thus, while ROE divides net profits by equity, in ROI (Economic return) it divides total assets, in addition to the fact that profits are not counted net but gross.
Indicators that measure profitability
The economic profitability is actually an indicator of the most used by companies to know the ability that it has to obtain benefits. But it is not the only indicator that can be used to measure profitability. In fact, there are others that can give more information about it, such as:
- Net profitability indicator. It offers a more "real" view, because it is based on net profit, but at the same time uses total assets, with which funds are both its own and others'.
- Gross Margin Indicator. In this case, it seeks to establish a relationship between gross margin and sales.
- Profitability operating margin. Also on sales, try to determine the difference between the profit of the sales and the sales itself.
- Financial profit. Where net profits and own funds (assets) are taken into account.
How to increase the economic profitability of a business
Once you know this term, the question you can ask yourself the most is how to get the profitability of a business to go up.
It must be made clear that this is not easy to achieve, but neither is it impossible. Therefore, below we leave you a series of tips that can help you increase the ROI of your business to obtain a greater gross profit that thus increases the net.
- Increase the price of your products. Yes, we know that it is something very risky, but it is necessary that you can obtain a greater benefit through the products. You also don't have to think about a strong raise, sometimes, with just a few cents, you get good results. In fact, it is a practice carried out by many companies, such as supermarkets that tend to raise the prices of some products several times a year. They do it minimally, for pennies, but the gross sales increase in a very positive way.
- Reduces production costs. In case you do not want to raise the price of the products, because it may imply that you are not going to sell what you should, another option is to lower production costs, that is, try to make those products cheaper in order to have a higher profit margin.
- Lower the price of the products. Yes, as before we have advised you to raise the price, another measure that can increase the economic profitability of a company is to lower it. In this way, what is intended is that there is an increase in the sales units that implies a greater profit despite the fact that the price is cheaper (because more is going to be sold).