Businesses are created for a single reason – to make money. While this may seem like a simple goal, it can be quite difficult. What’s even more difficult is determining the profitability of an entity, especially small-scale organizations. There are several elements in the financial statement, but only a few can help you track profitability.
This piece will review some of the best ways to review a company’s profitability. Don’t get scared of the huge numbers and complex terms. By focusing on the right KPIs, you can quickly determine if you’re on track to achieve success.
What are Profit and Profitability?
Before determining your profitability, you need to be familiar with the meaning and differences between two major terms – profit and profitability. Both terms may sound familiar, but they cannot be used interchangeably.
Profit means the total amount that an entity makes after all its expenses have been settled. This is calculated by subtracting total expenses (direct and indirect) from the total revenue. This value is indicated in the income statement as net profit.
On the other hand, profitability refers to how the business is performing. While the profit is calculated as a direct figure, profitability is relative. It’s measured as a percentage and used to forecast and analyze the success of your business.
What are the KPIs to Determine Profitability?
There are several ways to determine your firm’s profitability. They involve using certain KPIs to measure your success. These KPIs include;
The best way to determine your company’s success is through its gross or net profit. To determine your profitability ratios, you’ll need to calculate any of the following;
- Gross Profit = Net Sales – Cost of Goods Sold
- Operating Profit = Gross Profit – Indirect Cost
- Net Profit = (Operating Profit + Other Income) – Additional Expenses – Taxes
It’s possible to analyze these ratios further. They’ll help you determine your business’s efficiency.
If you sell physical products, the gross margin ratios are the best way to determine your firm’s profitability. It can be calculated using;
(Gross Profit/Total Sales) x 100 = Gross Margin Ratio
A high gross margin ratio means that you’ve earned a high amount of compared to how much you spent.
To calculate your Operating Margin Ratio, use this formula;
Operating Profit Margin Ratio = (Operating Income/Total Sales) x 100
The Operating Profit Margin Ratio determines the how healthy and quickly your company is growing. This ratio is supposed to increase over time. If the number stays the same, it means operating costs have resumed.
The net profit margin ratio is a real indicator of the firm’s profitability. To calculate it, use this formula;
Net Profit Margin Ratio = (Net Income/Total Sales Amount) x 100
This ratio shows how much your company can make from sales. The great thing about the operating margin ratio is that it includes taxes.
Profit Per Client (PPC)
Certain clients are more profitable than others. Using this metric will help you determine which clients to focus on. Even when a client pays a huge amount per deal, it doesn’t make them profitable. You can use the following formula to calculate profit per client;
Gross Profit Per Project (GPP) = Revenue from Projects – Project Expenses
Hourly Wage = Gross Profit Per Project / Hours Per Project
The hourly wage per project shows you how much you earn from each client. Ensure to focus on clients that offer a better hourly wage. A client may be paying a high fee, but if you’re also spending plenty of hours on their task, the hourly wage may be low. This type of deal is bad for business.
If you’re concerned about surviving as a business, you need to be able to determine its profitability. However, there are several ways to go about this. This piece focuses on several ways to calculate profitability. You’ll learn how healthy your company is by following the right steps.