Is Your Company Profitable? 5 Simple Steps to Check Your Numbers
Small business owners may be great at writing copy or designing interiors. But they might not be so comfortable with how to monitor the overall financial health of their business. There are many reports to run and numbers to check; it can be hard to know what to track. This article is a quick primer on how to stay on top of the big picture and make sure your company is profitable (and is on track to stay that way).
In this article, we’ll cover:
- Check Net Profit Margin
- Calculate Gross Profit Margin
- Analyze Your Operating Expenses
- Check Profit per Client
- List Upcoming Prospects
1. Check Net Profit Margin
Net profit is a key number to determine your company’s profitability. Use this simple formula to calculate net profit:
Revenue - Expenses = Profit
A positive number means you’re turning a profit. If it’s a negative number, your business is losing money. Zero means you’re breaking even.
For example, a business with revenue of $75,000 per year and $15,000 in expenses has a net annual profit of $60,000.
This article shows you how to track your revenue and expenses so you find net profit easily. Accounting software makes this process very simple as it automatically generates a profit and loss statement for your business. Profit is the last line on the report, as you can see in the example below.
Source: FreshBooks
It’s important to not only look at profits on an annual basis, but every month too. Check the profitability of the previous month on the first of the next month. How is your profit is trending? Is it about the same every month? Is it increasing or decreasing (and how fast)?
Now you can predict future profit and correct course if your profit is flatlining or taking a nosedive.
2. Calculate Gross Profit Margin
Gross profit is an important indicator of profitability level if you’re selling physical products. This number looks at how profitable your products are. Here’s the formula to calculate gross profit:
Sales Revenue - Cost of Goods Sold = Gross Profit
Cost of goods sold could include labor, materials and overhead costs.
Gross profit margin looks at what percentage of profit you’re keeping compared to how much your product’s costing. The formula is:
Gross Profit / Sales Revenue = Gross Profit Margin
A higher percentage means you’re keeping lots of profit compared to product cost. Anything less than 50 percent means your product is costing over half of your sales revenue.
A lower percentage is fine as long as your sales volume is high enough to pay your expenses. What gross profit margin shouldn’t be doing is decreasing. If that’s happening, it’s time to raise your prices or find ways to cut product costs.
Is your gross profit margin good but your net profit is decreasing? The best idea is to take a look at your overall expenses, like overhead. Product cost isn’t your problem.
3. Analyze Your Operating Expenses
Revenue increasing but profit decreasing? Check your expenses, they’re probably increasing faster than your revenue. When businesses grow, owners will sometimes invest the increased revenue back in the company without checking if their expenses are outpacing revenue.
Again, turn to your profit and loss statement and look at the line “total expenses.” Make sure you’re looking at expenses month by month and compare it to revenue month by month to find a trend. Are expenses creeping up to revenue? Have they already surpassed it? If so, it’s time to correct course and reduce expenses.
That said, some higher expenses are unavoidable, such as when you buy new equipment or add a new employee to the payroll. It depends on your industry; some require more capital than others.
4. Check Profit per Client
Some clients are more profitable than others. A business owner needs to know which clients are contributing the most profit.
Surprisingly, the clients that seem the most profitable, ones who pay big fees, may not be. Even if you’re charging these clients more, you could be incurring more expenses, as well. Sometimes smaller clients may be more profitable because the revenue to expenses ratio is better.
Unfortunately, you can’t rely on your accounting software to measure profit per client. So you’ll have to do a little math:
Total Project Fees - Project Expenses = Gross Profit per Project
Gross Profit per Project / Hours Spent on Project = Hourly Wage
Compare the hourly wage you receive for each project and then focus on getting more projects (and clients) that deliver a higher hourly wage.
5. List Upcoming Prospects
Profits should be spread fairly evenly over the year to help with cash flow. But, this doesn’t always happen. A big project can take up a business owner’s spring and then there’s little work over the summer. This is partly because the owner is so focused on the project they forget to line up new projects.
Keep a list of potential new projects somewhere you can see it. If the list is short, it’s best to do some marketing to attract new business. Profitable businesses are growing, not stagnant, businesses.
People also ask:
- What Is the Definition of Profitability in Accounting?
- What Is Return on Assets?
- What Is the Return on Assets Formula?
- How Can I Find a Return on Assets Calculator?
What Is the Definition of Profitability in Accounting?
The definition of profitability in accounting is when a company’s total income is more than its total expenses.
This number is called net profit, or income minus expenses, according to Iowa State University. Income is the total revenue a company generates. Expenses are a company’s costs, like marketing costs or product costs.
Profitability helps a business understand if their company is viable—whether it’s growing or sustaining losses.
What Is Return on Assets?
Return on assets (ROA) is a ratio that demonstrates what percentage of profit a company is making compared to its assets, according to Inc.. Assets are items of value such as inventory, accounts receivable (money owing to a company), equipment (minus depreciation) and property.
Companies with few assets will easily have a high ROA. For example, software companies have a high average ROA. Businesses with more capital (like car manufacturers) have lower ROAs.
What Is the Return on Assets Formula?
The return on assets formula is the following:
Net Income / Total Assets = Return on Assets (%)
The higher the percentage, the better a business is taking advantage of its existing assets. It is a company that’s being managed well.
To find your total assets, turn to the balance sheet on your accounting software. The average assets from the time period being analyzed should be used, as assets can come and go. Here’s an example of a balance sheet:
Source: FreshBooks
Net income can be found on your profit and loss report, also called an income statement.
How Can I Find a Return on Assets Calculator?
Use a Return on Assets (ROA) calculator to quickly find your company’s ratio. This free return on assets calculator from BankRate.com requires your net income and total assets—see the section above on how to find these numbers.
This ROA calculator from CCD Consultants helps you calculate your average assets, since assets levels can fluctuate. It also measures ROA as a percentage, as opposed to a ratio.
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