In order to assess the operational efficiency of a project and its profitability most of the industrially advanced countries employed various technique for the purpose of financial profitability analysis.
Profit is the primary objective of an enterprise. The word profit implies a comparison of the operations of business between two specific dates which are usually separated by an interval of one year. The maximization of profit within a socially acceptable limit implies that a proper regard for public interest has been shown. Really it is the growth of profit which enables a firm to pay higher dividends to its ordinary shareholders.
According to the Economists point of view profit is the reward for entrepreneurship. Various factors influence the profit variations. They are as follows.
- The volume of sales plays a tremendous part in profit making. So long as a sustained maximum volume continues at the top of capacity curve, break – even point would be far away.
- To attain real sophistication in profit calculation, the true profits at any given volume which should exist at a planned break even point are separated from the profits created by the performance at one attained volume.
- A change in variable costs and selling prices changes both the break even point and the marginal profit.
- The rate of marginal profit is affected by a change in variable costs, selling price and operating performance as against planned performance.
- When both the fixed and variable costs change and when they move in tandem, the effect of break even point is pronounced and definite. When they move in opposition to each other, the effect is very weak.
- The marginal break – even point is that point of output at which out of pocket costs are recovered. Depreciation and amortization costs are excluded from them.
All the business organizations ultimate aim is to earn a profit. But the first problem is to determine the factors which determine the level of financial profitability. Profitability should first measure the relationship between profits and the funds committed in the business to earn that profit. The first step in devising the strategy is to measure the task. For private industry the measure of task is the gap between the level of profit achieved by a business without the introduction of any major changes and the level of profit which the target profitability measurement indicates should be earned.
The measurement and control of financial profitability in a company or any other business organization should form one of the principal objectives of the finance function of a management.
Financial profitability is an indication of the efficiency with which the operations of the business are carried on. Poor operational performance may indicate poor sales and hence poor profits. A lower financial profitability may arise due to the lack of control over expenses. Bankers and other financial institutions look at the profitability as an indicator whether or not the firms earns substantially more than it pays interest for the use of borrowed funds and whether the ultimate repayment of their debt appears reasonably certain. Owners are very much interested to know the profitability as it indicates the return which they can get on their investments.