Profit versus profitability: what do you need to know?
Posted: Mon Jan 20, 2025 9:53 am
What is the main objective of any non-philanthropic company? Most people would probably answer: profit! However, not just any level of profit allows us to say that the company is achieving the shareholders’ objectives.
To perform a financial analysis , it is necessary to verify whether the magnitude of the profit earned by the company justifies the size of the shareholders' investment. Therefore, it is necessary to know the profitability of the business.
And how do you arrive at this calculation?
First, you need to understand that profitability is saudi arabia whatsapp data the profit divided by the shareholders' investment in the company, like this:
Profitability = profit / investment
It is also important to note that the concept of profitability seeks to relate the size of the company's profits to the size of the partners' investments . Only then can it be analyzed whether this relationship is at a satisfactory level for the investor.
What is a satisfactory level of profitability for a company?
Imagine a company has an annual profit of R$80,000.00, referring to an investment of R$1,000,000.00. Consider that this is the consistent and certain profit level for the next periods. In this format, the company's profitability would be equal to 8% per year, that is, R$80,000/1 million.
Now, let us suppose that the risk-free rate level of this economy, the Selic, for example, is 10% per year and that this is a stable rate. In this case, the company is certainly not achieving the shareholders' objectives.
This is because its profitability is lower than the risk-free rate, which can be considered a minimum opportunity cost for the investor. Therefore, in this case, the shareholder would not have any type of incentive to invest in the company. He could invest in some risk-free security and obtain a higher income, for example.
In general terms, the objective of companies is to obtain profitability that justifies the investor's opportunity cost. Therefore, this opportunity cost must reflect two variables:
# Minimum risk-free remuneration
# Additional remuneration for the risk taken in the investment
And this additional remuneration for risk depends mainly on two factors: the investor's risk appetite and the profitability of businesses with similar risks.
To perform a financial analysis , it is necessary to verify whether the magnitude of the profit earned by the company justifies the size of the shareholders' investment. Therefore, it is necessary to know the profitability of the business.
And how do you arrive at this calculation?
First, you need to understand that profitability is saudi arabia whatsapp data the profit divided by the shareholders' investment in the company, like this:
Profitability = profit / investment
It is also important to note that the concept of profitability seeks to relate the size of the company's profits to the size of the partners' investments . Only then can it be analyzed whether this relationship is at a satisfactory level for the investor.
What is a satisfactory level of profitability for a company?
Imagine a company has an annual profit of R$80,000.00, referring to an investment of R$1,000,000.00. Consider that this is the consistent and certain profit level for the next periods. In this format, the company's profitability would be equal to 8% per year, that is, R$80,000/1 million.
Now, let us suppose that the risk-free rate level of this economy, the Selic, for example, is 10% per year and that this is a stable rate. In this case, the company is certainly not achieving the shareholders' objectives.
This is because its profitability is lower than the risk-free rate, which can be considered a minimum opportunity cost for the investor. Therefore, in this case, the shareholder would not have any type of incentive to invest in the company. He could invest in some risk-free security and obtain a higher income, for example.
In general terms, the objective of companies is to obtain profitability that justifies the investor's opportunity cost. Therefore, this opportunity cost must reflect two variables:
# Minimum risk-free remuneration
# Additional remuneration for the risk taken in the investment
And this additional remuneration for risk depends mainly on two factors: the investor's risk appetite and the profitability of businesses with similar risks.