Every business owner wants to increase profitability. But many CEOs/business owners don’t know where to start or what to do. Business financial literacy classes are something that many of us didn’t take in school and there’s limited to no on-the-job training to help you get there. Every business owner deserves to have a business with a strong financial future.
Let’s look at two businesses, one owned by Jane and the other owned by Bob. Jane has had a very successful business for over 20 years. She’s recently made a significant investment in people to grow her business and is expanding her offices too. The cost associated with these investments were a drag on her profitability last year, but she’s making an investment in her future. The increased staffing and office expenses may have a drag on her profitability in the short term, but ultimately will produce sufficient revenue and profit to cover those costs and provide increased profit above her investment.
Since these expenses are operating expenses, they will impact net profit. So, tracking her net profit margin will be crucial, (net profit divided by revenue). Jane admitted that she had difficulty in understanding her financial statements and she wanted to learn how to keep score, so we walked through 2 important KPIs (key performance indicators). In addition to net profit margin, another KPI is the gross profit margin (gross profit divided by revenue). This gives Jane an understanding of her margin before and after operating expenses.
Bob has a wholesale business that was started in the 1960s and he’s the second-generation owner. His revenue has grown 42% over the past 4 years, but his net profit has grown 75%. Bob’s gross margin has remained stable, which means he’s been able to pass on product cost increases to his customers. His operating expenses have increased, but not at the same rate as sales, which is what is causing his net income growth. Bob has already made the people investments in prior years and is reaping the benefit of those investments with higher net profits. His net margin increased 23% year over year. Bob tracks his gross and net profit margins too.
Profitability is a key indicator of a company’s financial health and sustainability, as it determines the viability of the business in the long run. Without profitability, a business may struggle to cover its costs, repay debts, invest in growth opportunities, and reward its owners and investors.
