Profitability is or should be the primary goal of every business venture. As former American radio commentator Rush Limbaugh stated, “Everybody ought to relish profitability.” Profitability is the key measure of a business’s success. That’s why a small business profitability analysis is an essential tool for small business owners.
Why Business Profitability is Important
Business profitability is important because no enterprise can exist in the long term without profits. Profitability funds growth, including market expansion into new markets and the addition of new products and new services. It enables and enhances a business’s ability to borrow money and enables an enterprise to pay down debt. It builds critical working capital. It helps to attract investors and hire and retain employees. It is an important contributor to employee confidence and satisfaction. It increases the market value of a business. It is a prime way that outsiders and stakeholders, including investors, lenders, and vendors, measure the effectiveness of a management team. Businesses that achieve increased profits can use their profits to enhance product quality, boost marketing, and, in other ways, seek competitive advantages. Higher profits can lead to a set aside of reserves, thereby leading to reduced business risks. Business owners can benefit by utilizing a small business profitability analysis to enhance their profitability.
How to Conduct a Small Business Profitability Analysis
A small business profitability analysis is simply a way that business owners review the financial performance of their enterprise to understand the company’s efficiencies and deficiencies and determine where improvements are needed. That enables them to pursue future growth in revenues and earnings. Specifically, a small business profitability analysis enables a business owner to understand what areas of the business are driving profits and which ones are draining profits. It can identify where fixed and variable costs need to be reduced. It can help to evaluate operating efficiencies and areas of inefficiencies. It can help spot opportunities to change the business’s product mix or alter pricing. It can also help spot and correct cost and profitability trends.
The steps to conducting a small business profitability analysis are:
- Collect financial data from the business’s financial statements.
- Perform a break-even analysis. That can include a break-even analysis of the entire business, individual products/services, or customers. You can test the break-even analysis using different pricing and cost scenarios.
- Conduct profitability ratio analysis using these measures: gross profit margin, net profit margin, operating profit margin, margin per customer, and cash flow margin. Also, examine these revenue ratios: return on assets and return on equity.
- Compare the business’s profitability to industry benchmarks.
- Take appropriate action.
Ways to Increase Business Profitability
You can leverage your small business profitability analysis to improve profitability by cutting expenses, focusing on margins along with cash flow, adjusting pricing, automating business processes using technology, seeking more repeat sales from existing customers, finding more customers, adding new products or services, and developing ways to boost employee efficiency.
Seek Professional Accounting Assistance
Contact Orcutt & Company, based in Milford, OH. We deliver comprehensive financial management for small business owners and individuals, providing strategic solutions that best address client needs and aspirations. Our comprehensive accounting services keep you organized and give you the data you need to make prudent business decisions, including bookkeeping, payroll, and tax.
