Financial profitability is the profit that an investor obtains.
Financial profitability is the benefit obtained through certain resources in a specific period of time. The concept, also known as ROE for the English expression return on equity , usually refers to the profits that investors receive.
It should be noted that profitability is a condition of what is profitable : that is, that generates income (profit, utility, gain or profit). Financial , for its part, is what is associated with finances (linked to flows or money).
Calculation of financial profitability
What financial profitability does, ultimately, is reflect the performance of investments . To calculate it, the results obtained are usually divided by the resources or own funds that were used: Net result / Own funds to their net status . But this equation can have other numerators, as seen below:
- Result before taxes : with the objective of measuring the return on equity independently of corporate tax.
- Result from ordinary activities : so that it is possible to ignore the effect caused by extraordinary results and corporate tax.
- Result prior to deduction of provisions and amortization : since it is not easy to estimate these costs and they can distort the real result.
- Operating result after deducting both direct taxes and debt interest .
Let's look at a simplified example. Suppose a person invests $10,000 in stocks and, after a year, sells them for a profit of $2,000 . According to the aforementioned equation, the financial return on your investment was 20% .
Financial profitability can be calculated in different ways.
Benefits and resources
The calculation of financial profitability, therefore, will vary according to how the concepts of benefits and resources are understood. Profits can be measured before or after paying taxes , as we have already seen, which will change financial profitability. Regarding resources, own funds are usually used and not those that the investor generated by contracting debt.
For all companies and investors, the objective will always be to maximize financial profitability: the higher the profitability, the higher the net profits. If two investments are compared, the most profitable will be the one that offers a better relationship between profit and amount disbursed.
Other considerations about financial profitability
It is important to note that if financial profitability is insufficient, a limitation is created that blocks access to new own funds in two ways: first, the low level indicates that the funds produced internally by the company are scarce; Furthermore, this may result in certain external companies refusing to provide you with financing services , for fear that you will not be able to pay your debts .
That said, it is understood that the financial profitability should be in line with what the investor can perceive in the market plus a value that protects him from potential risks inherent to his role as a shareholder. Despite this, it is important to emphasize that financial profitability refers mainly to the company and not to the shareholders, even though own funds do represent their participation .
First of all, if we wanted the financial profitability to refer to the shareholders , the calculation should include some magnitudes in the numerator (where, for example, the net result is so far), such as dividends, distributable profit and variation in the quotes; In the denominator, on the other hand, it would also be necessary to take into account the investment corresponding to the remuneration.
Therefore, the concept of financial profitability contemplates the structure of a company from a financial point of view, taking into account its investments and the results of its operations , but also the factors that are included in economic profitability.