Profitability definition
/What is Profitability?
Profitability is a situation in which an entity is generating a profit. Profitability arises when the aggregate amount of revenue is greater than the aggregate amount of expenses in a reporting period. If an entity is recording its business transactions under the accrual basis of accounting, it is quite possible that the profitability condition will not be matched by the cash flows generated by the organization, since some accrual-basis transactions (such as depreciation) do not involve cash flows.
Profitability can be achieved in the short term through the sale of assets that garner immediate gains. However, this type of profitability is not sustainable. An organization must have a business model that allows its ongoing operations to generate a profit, or else it will eventually fail.
Profitability is one of the measures that can be used to derive the valuation of a business, usually as a multiple of the annual amount of profitability. A better approach to business valuation is a multiple of annual cash flows, since this better reflects the stream of net cash receipts that a buyer can expect to receive.
How to Measure Profitability
Profitability is measured with the net profit ratio and the earnings per share ratio. The net profit ratio compares after-tax profits to revenues, while the earnings per share ratio presents profits on a per-share basis.