While many business owners go into business to pursue their passions and have a larger purpose in mind, the bottom line will always matter. If your company is not profitable, you likely cannot continue to pursue your passions and fulfill your purpose. While it’s not always easy to talk about — or think about — your profits and losses in business, it is necessary. Now you just need to know what to look at to determine your business’s profitability.
1. Net Profit Margin
The first metric you should look at to determine if your business is profitable is your net profit margin. This metric is a mathematical calculation that divides the company’s net income by the revenue. (Net income is how much money your company took in after all your expenses.) Then, you take that number and multiply it by 100 to get a percentage. This percentage represents the amount of each dollar a company takes in that can be seen as profit.
If, for example, your company brought in $100,000 in revenue but you spent $75,000 in operating expenses, your net income is $25,000. Divide that number by $100,000 and you’ll get .25. Multiply .25 by 100 and you’ve got 25%. Your net profit margin is 25%, which means 25% of every dollar you make is profit. You can then use this metric to see if you can tweak an area in your expenses to increase your revenue. Next, you’ll want to look at gross vs net profit margins.
2. Gross Profit Margin
While finding your net profit margin can get tricky because you need to locate and calculate your company’s operating expenses, calculating gross profit margin can be much simpler. This process requires you to divide your gross profit (the income you take in after the cost of goods sold) by total revenue. This calculation leaves out items like taxes, rent, interest payments, freight, etc. It allows you to see how much profit your company brings in purely from the production.
Using the same numbers above, your revenue is still $100,000 but your gross profit is $85,000. Now the calculation is $15,000 divided by $100,000, which gets you .15. Multiply .15 by 100, and you have a 15% gross profit. It’s important to note that each industry has different high, low, and average net and gross profit margins. In general, a “healthy” profit margin for a small business hovers around 10%. Accounting software can help you break these numbers down and track them over time.
3. Operating Expenses
Once you understand your profit margins, track your operating expenses to see where you can save and where you should spend more. Yes, it’s true, there are many times when you don’t want to cut costs. Lowering your budget and skimping on essential expenses can result in a decline in quality and, as a result, few paying customers. It can actually be detrimental to your business.
Monitor your operating expenses with an eye for what your customers want and then deliver it without breaking the bank. Items like food, customer service, or quick delivery often require you to follow the “spend money to make money” adage. But maybe you could cut costs in rent and utilities or eliminate unnecessary expenses that don’t contribute directly to the customer experience. It’s a numbers game, and it’s up to you to learn how to play it well.
4. Profit-Per-Client
The profit-per-client metric lets you know how much money your business is earning from each client you have. To calculate this number, you divide your gross profit by your total number of customers. If you have 1,000 customers and your total profit is $10,000, your profit-per-client is $10. This means you are making $10 per client, on average. Of course, like with profit margins, these numbers will vary widely in different sectors.
It’s important to measure customer profitability because it can help you identify which segments of customers are bringing in more profit, and then you can analyze why. If you just ran a campaign, did your PPC rise? Did you release a new product? How did your PPC change? Tools like Google Analytics can help you track changes in your customer’s online behavior on your site, which can add further insight into what changes you might want to make in response.
5. Future Prospects
Finally, predicting future prospects is a huge part of your company’s profitability. You’re surely familiar with a business or two that make their profits off one-time customers. The products and services may not be great, but the lure to make the purchase might be strong. Typically, this model is not sustainable because word eventually spreads from enough unhappy customers, and new prospects know to stay away.
You can measure your future prospects by tracking how many warm leads you have in your sales funnel. You can also look at how many repeat customers you have had in the past when you expect them to return. Another option is to analyze responses to ad campaigns and determine how many you plan to run. Of course, you won’t always nail the numbers down exactly, but it’s critical that you keep looking forward at your company’s future potential.
In the end, there is a wealth of tools available to help you run the numbers on your profits, losses, expenses, and client behavior. Compiling and understanding the data central to your business will help you make smart decisions. Remember, you can have a great product, fiery passion, and a wonderful purpose, and still flounder in business without a clear strategy to keep your company running. Use the numbers at your disposal to maximize your potential for success.
Lynn Martelli is an editor at Readability. She received her MFA in Creative Writing from Antioch University and has worked as an editor for over 10 years. Lynn has edited a wide variety of books, including fiction, non-fiction, memoirs, and more. In her free time, Lynn enjoys reading, writing, and spending time with her family and friends.
