Many businesses started as simple rough ideas which have been refined over time to meet set standards. In all this, the biggest question behind any efforts is whether or not the founders will be able to reap profits, and how much of it. This is perhaps a popular question amongst small business owners who despite facing the numerous challenges of setting up the business, still need to find out if the pursued venture is profitable or not. In this article, I attempt to give a brief rundown of some of the basic steps to follow to ascertain if the business is making a profit or not.
What Is Profitability Accounting
To understand how your business makes profits you need to appreciate what is meant by profitability accounting. In simple terms, this is a process where business total income and expenditures are compared to find the difference. The difference will either be labelled a loss or a profit. Several ways can be implored if one is to assess whether or not a perused venture is profitable. However, to easily assess the profitability of your company, you must have an appreciation of how the business gets its income and how its expenses are structured.
Figure Out Your Margin Ratios
Margin ratios always work much in attempts to calculate the profitability of a business. Here you try to figure out how your business converts sales into profit and this is achieved by knowing how much income per $1 of sale your company will make. A company might have a net income of 0.30 per dollar of sale which will be a 30% margin ratio.
Calculate Profit Per Item
Depending on the nature of your business, it is always wise to distil everything down to the individual units you sell. This is also known as gross profit margin calculation and it is arguably the most basic level for a start-up to find out whether or not the business is profitable. For this, the cost of production/delivery is calculated and is deducted from the actual selling price and the remainder is your profit. A simple formula for this will be:
Sales Revenue –Cost of Goods Sold = Gross Profit.
You should know that when calculating the cost of goods sold, we factor in such elements as labour, material, overhead costs and other expenditure incurred during the provision of the good or service.
Know Your Fixed And Variable Costs
Costs to a business come in various structures and it is important to be on the constant lookout for them especially the hidden costs. Knowing your variable and fixed costs will be of great importance if you are to calculate whether or not a business is profitable. Fixed costs are those constant expenses that do not vary according to the business turnover. On the other hand, variable costs may be larger or smaller depending on the sales of the given period and you need to know the trends of each in your business.
Analyse Your Operating Expenses
At times, small business owners allow their businesses to bleed a lot of cash which could otherwise be accumulating as profits. Now, every business is always faced with several expenses and some have justified the need for working capital. Now, when you fail to keep an eye on your working capital, you will find your business running out of cash to expenses. It is recommended to keep a close eye on a business` expenses and ensure that they do not eat too much into the working capital. We wouldn’t want a situation where a businesses revenue is reinvested back into the business without checking if expenses are in line with revenue. To optimise expenses, you need to compile all your monthly expenses preferably if you do it month by month. Compare the figures with your monthly revenue and see if the numbers are making sense. Ideally, you want a situation where there is more revenue than expenses.
Analyse Your Gross And Net Turn Over
Gross turnover comprises all the money that goes into a business` cash before bills are paid. You always want to know how much money has passed through your hands before you disburse it to expenses. After meeting all your accounting obligations either in taxes, salaries etc what remains is the net turnover to your business. It is from such that you will know how much money is needed either to restock or grow the company and what remains as profits.
Do Your Break-Even Analysis
The break-even point is a state where your business expenses and revenue are equal. In simple terms, this is the borderline between profit and loss to a business and what you want is for your business to be on the positive side of the scale. The most ideal situation as has been mentioned is when your business revenues exceed expenses which would mean that you are running a profitable business. So, to find out your break-even point, calculate the costs of labour, material and other such expenses incurred in produce a good or service. The total from that will act as the base from which you set your profit margins. It could cost you $1 to offer a service, depending on demand and other market variables, you can decide to take $0.30 profit for each $1 spent. Hence your break-even price will be $1 and if you charge less then you are at a loss and the opposite is true for profits.
If you use any of the above techniques you will get the general picture of whether or not your business is profitable.