Understanding if your business is truly profitable goes beyond just looking at the cash in your bank account at the end of the month. (Although I believe that ‘Cash is king’). True insight into your business’s health comes from analyzing its profitability, reflecting its operational efficiency.
Efficiency and profitability go hand in hand – knowing how well your business operates helps you understand its profitability.
As you are likely aware, measuring a company’s profitability involves clearly understanding what ‘income’ and ‘expenses’ mean.
Income includes the revenue from sales or services provided, while expenses cover all costs incurred to operate your business, such as salaries, rent, and materials. To calculate profitability, you subtract the total expenses from the total income.
Examining the profit and loss (P&L) statement is essential for gaining deeper insights into your business’s profitability.
This financial document provides a detailed breakdown of your revenues and expenses over a specific period. For instance, if your P&L statement shows a consistent increase in net income over consecutive quarters, it indicates a positive trend in profitability. You should be able to retrieve your P&L statement easily from your bookkeeping system.
To effectively measure profitability, consider these key components within your P&L statement:
Gross Profit: Derived from subtracting the cost of goods or services sold, from sales (revenue). This indicates the efficiency of your production or service delivery, revealing how well you control direct costs.
Operating Profit: Reflects earnings from core operations, calculated by deducting operating expenses from gross profit. This shows the operational efficiency and the profitability of your core business activities.
Net Profit: Represents the comprehensive profitability after all expenses, including taxes and interest, are subtracted from total revenue. This provides the bottom-line earnings, highlighting the overall financial health of your business and its ability to generate profit beyond operational and non-operational expenses.
Maintaining well-organized bookkeeping enables easy access to these crucial measurements, supporting strategic decisions based on accurate financial information.
Analyzing profitability is relatively straightforward for a business with a singular product or service line. However, when your business covers multiple offerings, figuring out the profitability for each part becomes complex.
A business that offers different kinds of services or products needs to examine the profits of each segment to make smart decisions. Understanding the details helps the business use its resources well and improve its finances and operations.
Think about an IT service provider company that offers: cloud computing, cybersecurity, and custom software development.
𝗘𝘅𝗮𝗺𝗶𝗻𝗶𝗻𝗴 𝘁𝗵𝗲 𝗽𝗿𝗼𝗳𝗶𝘁𝘀 𝗳𝗿𝗼𝗺 𝗲𝗮𝗰𝗵 𝘁𝘆𝗽𝗲 𝗼𝗳 𝘀𝗲𝗿𝘃𝗶𝗰𝗲 𝗰𝗮𝗻 𝘂𝗻𝗰𝗼𝘃𝗲𝗿 𝗸𝗲𝘆 𝗶𝗻𝘀𝗶𝗴𝗵𝘁𝘀. For instance, if cybersecurity services turn out to be the most profitable area, they might need more attention and investment.
This way of checking profits by service type is crucial for guiding the company toward areas with the most growth and profit potential.
Doing this detailed financial review isn’t just about watching the numbers but about guiding your business to steady growth and strength.
It gives business leaders the information needed to make smart decisions, ensuring the company’s long-term success.
The real challenge, however, comes from calculating the overhead costs.
Overhead costs are expenses not directly linked to any specific service but are essential for your business’s operation, such as rent, utilities, and administrative salaries.
Why is this so important? Accurately identifying these overhead expenses reveals the true profitability of each service you provide.
For instance, if you find your cybersecurity service is not just bringing in more money but also has lower operating costs compared to your other offerings, focusing more on this service could be a strategic move.
𝗧𝗵𝗲 𝘁𝗮𝘀𝗸 𝗼𝗳 𝗮𝗹𝗹𝗼𝗰𝗮𝘁𝗶𝗻𝗴 𝗼𝘃𝗲𝗿𝗵𝗲𝗮𝗱 𝗰𝗼𝘀𝘁𝘀 𝘁𝗼 𝗲𝗮𝗰𝗵 𝘀𝗲𝗿𝘃𝗶𝗰𝗲 𝘁𝘆𝗽𝗲, 𝗮𝗹𝘁𝗵𝗼𝘂𝗴𝗵 𝗶𝘁 𝗶𝘀 𝗰𝗵𝗮𝗹𝗹𝗲𝗻𝗴𝗶𝗻𝗴, 𝗶𝘁 𝗶𝘀 𝗮𝗰𝗵𝗶𝗲𝘃𝗮𝗯𝗹𝗲.
Often, companies benefit from the expertise of a financial professional to help them through this complex process.
