Four Steps to a Successful Profitability Analysis
Are you uncertain about the level of success you achieved? There's a quick way 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 a 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.
Step #1. Calculate Margins
Two of the most important variables in a profitability analysis are gross and net profit margins.
You can get the gross profit margin by knowing your sales revenue minus the cost of labour.
For the net profit margin, you must subtract all expenses from your revenue to get the magic number - the margin - and then divide the previous result by your revenue
Don't forget to look at the segment profits, too.
Odds are you offer a suite of services that each has its own revenue stream. Take the numbers for each segment, subtract the costs, and include overheads in your calculation.
If you do this, you get a more detailed insight into how money moves in your business.
Step #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. So, subtract from the revenue all of your costs, such as marketing, hourly labour, travel expenses, and so on.
After all, you want to find out the costs of keeping each client satisfied.
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.
Step #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.
Step #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.