Why profitability is important in business
The basis of establishing a successful business is ensuring a positive bank balance, with a healthy amount of cash available for running expenses. There are, however, a number of factors that can impact the amount of cash on hand, and entrepreneurs would be well advised to have a few tricks up their sleeve when it comes to maximizing profits.
Cash flow represents the cash coming and flowing out of your business. When cash going out is subtracted from cash going in, you are left with net cash flow. Profitability represents the income minus the expenses, fixed and otherwise, of your business. When expenses are subtracted from income the resulting number shows your profit. Cash inflows and outflows show liquidity while income and expenses show profitability. Liquidity is a short-term phenomenon: Can I pay my bills? Profitability is a medium-term phenomenon: Am I making money? Needless to say, profitability in the long term is where it’s at.
Profitability allows you to invest in growth, expand your operations, and generate more revenue in the long run. Profitability also makes your business attractive to investors and lenders, as they want to see a solid return on their investment. Without profitability, you won’t keep the doors open for long, and you may have to resort to cutting corners or taking on debt to keep everything going. By focusing on profitability, you can ensure the sustainability and longevity of your business venture, while also creating value for your stakeholders.
How can profit be calculated
The profitability of a business can be calculated using various financial ratios, each with its own formula. Here are some of the most commonly used profitability ratios:
- Gross Profit Margin = (Gross Profit / Revenue) x 100 This measures the percentage of revenue that is left over after deducting the cost of goods sold.
- Net Profit Margin = (Net Profit / Revenue) x 100 This measures the percentage of revenue that is left over after deducting all expenses, including taxes and interest.
- Return on Assets (ROA) = (Net Profit / Total Assets) x 100 This measures how efficiently a company is using its assets to generate profit.
- Return on Equity (ROE) = (Net Profit / Shareholders’ Equity) x 100 This measures how much profit a company is generating in relation to the amount of equity invested by shareholders.
These formulas provide different perspectives on a company’s profitability and can be used to evaluate its financial health and performance. If all these calculations are outside your level of expertise, contact the accounting experts to advise on which area of your finances to concentrate on.
Here are 5 strategies to Help Your Business Maximize Profits
In general, there are four areas of operations that can be used in order to turn the tide on profits.
- Increase price
- Increase volume sold
- Decrease direct costs
A more detailed breakdown of these gives you five concrete strategies to help your business maximize profits.
- Increase sales volume: One way to maximize profits is to increase the number of sales your business makes. This could involve increasing marketing efforts to reach a larger audience, offering discounts or promotions to encourage purchases, or expanding your product line to appeal to more customers.
- Cutting costs: This could mean negotiating better deals with suppliers, reducing unnecessary overheads, or outsourcing certain tasks to more cost-effective and specialized providers.
- Increase prices: If your business has a unique or high-quality product, you may be able to increase prices without sacrificing sales volume. However, it’s important to be careful when raising prices to ensure that your customers are still willing to pay the higher amount.
- Focus on customer retention: Acquiring new customers can be expensive, so it’s important to focus on keeping existing customers happy and coming back for more. This could involve offering loyalty rewards programs, providing exceptional customer service, or regularly engaging with customers through social media or email marketing.
- Diversify revenue streams: Maximizing profits by diversifying your revenue streams to reduce reliance on a single product or service. This could involve offering complementary products or services, expanding into new markets, or developing new revenue streams entirely.
Outsourcing has become a popular strategy for many businesses to maximize profit. Outsourcing allows access to expertise that may not be available in-house, as and when needed. By outsourcing to experts in specific fields, businesses can improve the quality of their products or services and gain a competitive advantage in the market, without having the monthly expense of a fixed salary to contend with. Outsourcing can also maximize profit by increasing productivity. By outsourcing non-core and repetitive tasks, businesses can free up their time and resources, allowing them to focus on their core competencies and strategic goals. For example, outsourcing administrative or back-office tasks can help reduce administrative workload, allowing key personnel and management to work on growing the business and generating more revenue.
Outsourcing can help your business increase profits and gain a competitive advantage. However, it is important to carefully evaluate your outsourcing partner to ensure that the quality of the outsourced work meets the standards of the business.
Running your own business can be complex and challenging, especially juggling the stresses of your day-to-day operations with long-term financial planning and goals. However, profitability and optimization are key to longevity, but these need careful planning and strategic implementation, using a skillset that you might not have in-house. An outsourced CFO can be your best option here, assisting with business analysis as well as financial management. Talk to the team at OCFO and learn how we can help you maximize profits for your business in the long term.