Profitability Analysis is a very essential branch of financial analysis and a must study of Financial Modeling. Anyone looking forward towards attaining a Financial Modeling certification needs to have firm knowledge about the concept. Let’s discuss the basics of profitability in this post.

Profitability analysis is a branch of financial analysis that consists in putting measures of profit into perspective. As for example: a company that has made a profit of $1m in year 2011 doesn’t tell us much about how good its performance was, which effort was deployed to achieve this performance or what level of capital the company operates with to attain such a profit level. Profitability analysis shed some lights on those aspects.

Also due to the need for a relative measure of profit rather than absolute profitability analysis is essential. At a fundamental level investors need a sound measure of how good an investment is compared to another one. The concept of internal rate of return or IRR is such a measure.

One of the influencing factors of profitability is costs. Costs impact profit directly and for this reason, a good understanding of costs structures can help to increase profitability. Profitability of a particular project is usually a fairly objective measure. When a company already has several projects on its business, the profitability of a new project can result from synergies and diversification with existing projects. This is called relative profitability. Few of the major factors that come within profitability analysis are stated as below.

The Internal Rate of Return (IRR)

  • Comparing the profitability of different projects

Analysis of costs

  • Fixed costs versus variable costs
  • Break-even analysis

Opportunity cost

  • Relative project profitability
  • Modeling competitors

Various measures of profitability

  • Cash-flows patterns and uncertainty

We will discuss about IRR and related concepts in our forthcoming blogs. To know more about Profitability Analysis and related concepts, you can explore our training courses on Financial Modeling. Simplilearn offers both online training on Financial Modeling.

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