Category: Finances

How To Measure A Business’s Profitability

The financial well-being of your business is based on multiple elements, one of the most prominent of which is the amount of money you’ve generated. You have of course the gross revenue that you should subtract from your overhead costs and expenses to calculate the actual profits.

It’s for this reason that business owners should learn about how profitable their business is currently, in the past, and future. It will help them avoid money pits or know when to “fold them” in terms of supporting a startup.

What’s Profitability in the First Place?

Profitability is the percentage or ratio between a business’s profit and its expenditures. It helps you figure out the financial health of your business and what adjustments you should apply moving forward.

You can calculate your income by how much your business generates money through activities and operations. You can then figure out what your expenses are by calculating the number of resources you consume as your business operates. This includes money, time, and inventory.

How to Measure Profitability

In broad-stroke terms, you can measure how profitable your business is by dividing your profit or income (your gross revenue minus your expenses) by your revenue then multiply it by 100 to get a percentage figure.

  • Small Businesses Should Pay Attention to Profits: Small businesses in particular should pay attention to measuring how profitable their business is to ensure their future survival and to make adjustments in marketing and production from the start instead of late down the line.
  • Pro Forma and Project Income Statements: Measure the profitability using a pro forma income statement. This statement measures expenses and income for the upcoming period. Or you can acquire project income statements to know if a business change or paradigm shift is favorable or not.
  • Return-on-Assets Measurement: Do a return-on-assets measurement to compare revenue and assets. Divide net income before taxes by total assets, then multiply the result by 100 to determine your return on assets.
  • Ensuring Cost-Efficiency: The higher the number of the measurement the more efficient you are with your business resources. You can make your business more cost-efficient by basing your business decisions on this metric.

How Can You Use This Information?

Business owners can use the info to assess how viable their business model is through an income statement. This report details the expenses and profits of your company through any given accounting period. Every business decision should be supported by an informed opinion.

Profit margins and figures help you determine if your projects are working or failing. There are times when it’s okay for a company to not be profitable for years until they do start generating an income like with Amazon, but it’s with the understanding that it’s a gamble regardless.