The entrepreneur who has just embarked on his journey, has multiple priorities such as GMV, Customer Acquisition, social media presence, cash-flows amongst others. The critical priority, for a sustainable business, however, is profitability. Business is unpredictable, the only thing one can count on is that everything changes. You need to constantly measure your business performance so you know the profitability of your company.
Defining what Profitability is…
Profitability is the surplus revenue a company generates with respect to its expenses by the usage of resources at its disposal. In simple terms, it is what you are left with, after subtracting the expenses. Positive, indicates you have profits, negative, indicates, losses.
It is a key indicator of the firm’s sustainability and is of two types:
Accounting Profits
The fundamental analysis of a company involves calculating the Business profits using the “accounting profits”. Accounting profits provide you with an intermediate view of how long your business will survive. Although one year of losses may not permanently harm your business, consecutive years of losses or a net income insufficient to cover on going expenditures may jeopardize the viability of your business.
Computation of accounting profit requires one to deal with certain terms such as Net Income(sales less COGS, selling, general, operating expenses, interest, and tax expenses), Gross income (profits before deducting taxes), operating profit, investment profit etc.
Accounting profit is given by [Total Revenue – (Cost of Goods Sold + Operating Expenses + Taxes].
Economic Profits
In addition to deducting business expenses, opportunity costs are also deducted when calculating “economic profits”. Opportunity costs relate to the benefits that are missed out on while choosing one alternative over another. If you are not producing a particular product or service at the moment, you would have your money invested elsewhere or be employed in an alternative. Opportunity cost is deduced, along with ordinary business expenses, in calculating economic profit.
Economic profits provide you with a perspective of your business regarding its sustainable profitability. If you can obtain better benefits by income by using your resources elsewhere.
Economic profit is given by Accounting Profit – Implicit Costs
Key contributing factors to profitability that need constant attention to are:
- Expenses: Expenses (operational, selling, COGS, admin etc.) need to be tracked regularly and recorded meticulously, to get a fair understanding of which operation or process is most cost incurring.<should it be operating expenses?>
- Receivables: It is the amount due, towards the company by the customer for the company’s services or products. Timely collection of receivables can’t be stressed on enough, as a start-up or small firm, you will always need flowing capital at hand to increase services and functionalities.
There are many methods for assessing your firm’s profitability, a few of which are:
- Assessing your Financial Statements
Financial statements are indicators of various things about the firm like the firm’s financial strength, profitability, longevity, efficiency of management and the overall business trend.
Increasing profitability is one of the most important tasks of the business owners. A variety of profitability ratios be used to analyse the profitability of a business.
Profit Margin Ratios
The profit margin ratio can be calculated by dividing net income by net sales, various kinds of profit margins are used to measure a company’s profitability at various cost/expense levels. The margins shrink as layers of additional costs are taken into consideration, such as the cost of goods sold (COGS), operating and non-operating expenses, and taxes paid.
There are four key areas that improve your profitability
- Manage your costs
You can manage your costs better by planning, processing, controlling and drawing out the budget of a project or business. It includes processing the funds received and payables in a given period of time.
- Review your offer price
Consider modifying the price of your product or service to match the market stats and the customer demands, making the prices neither too high nor too low.
- Buy more effectively
Maintenance and tracking of inventory prevents multiple orders and supports economic ordering. This leads to reduced COGS when raw materials or parts are bought in bulk.