Achieving a Successful Profitability Analysis
Are you uncertain about the level of success you achieved? Here are some quick ways to get an overview of your finances.
Not enough companies run a profitability analysis - a defining indicator of profit. Such an analysis relates to costs and overall revenue and it can provide insights into how your business runs.
The occasional analysis can also indicate if it's time to make some changes.
Maybe some clients require too much time for the money. Perhaps there are other opportunities around the corner that you can jump on.
Either way, it should be on your list of tasks if you want to ensure long-term business growth. And here's a simple blueprint to follow for a successful profitability analysis.
1. Calculate Margins
Two of the most important variables in a profitability analysis are gross and net profit margins.
To calculate your gross profit margin, you need to know your sales revenue and cost of sold (COS). You may see COS referred to as COGS, which is similar but means cost of goods sold.
For the net profit margin, you take your gross profit and deduct the rest of your expenses and overheads.
You can also find the profit margins for certain categories too by isolating the sales and COS that relating to that categories. Categories can include, locations, product lines, sales employees, whatever is for important for you to identify and track. If you do this, you get a more detailed insight into how money moves in your business.
2. Perform Client Valuation
Here, you must look at each client and figure out how much each of them brings. Performing a client valuation essentially means to determine the worth of each client.
For each client, look at the revenue generated from them and deduct any client specific costs, such as labour, travel to their premises and any materials purchased specifically for them. Once you have the gross profit (revenue - COS), divide it by the revenue figure used to calculate the margin.
How do the clients compare? Are there some that are bigger income streams, but require a lot of resources to satisfy that income? Some clients may not pay a lot for your services. But you may have a better profit margin with them if their projects take very little time from you or your team.
Maybe you have good cash flow. But it's possible that when you draw the line, there's not a lot of profit in it.
3. Look at the Past Numbers
A thorough profitability analysis looks at past quarters over the years.
Although your current numbers may look good on paper, you need something to compare them to if you want to know where you stand. Knowing if your profitability is improving or going down hill is important so that you can make changes in real time rather than a year down the line. It can also help you to spot trends and plan ahead.
4. Benchmark Industry Ratios
Your numbers only mean something in the context of your niche. It’s because profitability numbers aren't the same in accounting as in health care, education, e-commerce, etc.
If you look at your past and current numbers, you can figure out your business's progress so far. But what about compared to your competitors?
What about your position in relation to the market?
Always be sure to check average industry ratios to give you a better sense of where your company is as opposed to where it should be.
Do It for Peace of Mind and Direction
A good profitability analysis can help curb anxiety when it comes to your business. At the same time, it can tell you what you should be doing to improve and grow it.
If you ever find your business lacking direction, remember that an analysis can help you spot issues that you couldn't otherwise.
It’s a game changer.