Profit is the positive financial gain your business makes after you've subtracted all your expenses. The ability to generate profit is crucial to the survival of your business. It is about more than just making money - it's also about the ability to use surplus funds to invest in and grow your business in the future.
Profit is not the same as cash or sales, and it's not the money in the bank or on hand. Profit is represented 'on paper' in your accounting system.
To be more profitable you need to understand the concepts of profit margins and profit drivers. You can then develop strategies to increase your profits, including ways to increase your sales revenue, your profit on individual products and services, and decrease costs.
You can use the tools, diagrams and tables in this guide to help calculate your profit goal, minimum sales requirement and to chart the most important products for your profit margins.
This guide explains how to make your business more profitable by helping you identify and understand the financial factors that affect it.
Your gross profit margin is a key indicator of your business's overall health. The gross profit margin shows whether the average mark up on your products or services is enough to cover your direct expenses and make a profit.
To calculate your business's gross profit margin, you first need to calculate gross profit.
Use the following interactive calculators to help you work out your gross profit margin. Once you have read and understood the examples, you can type the numbers that are relevant to your business into the calculators to see your gross profit, and your gross profit margin.
Gross profit is a valuable measure of your pricing policy, sales volume and cost of goods sold.
Gross profit margin is gross profit expressed as a percentage of sales.
Below is an example profit margin for a bakery that sells sweet rolls, savoury rolls and a variety of bread loaves.
For each of their products, the cost of goods sold (cost to make), sales revenue (sale price), gross profit (sales revenue minus cost of goods sold) and gross profit margin are listed.
|Product||Cost to make||Sale price||Gross profit||Gross profit margin|
If the bakery sold 180 loaves of bread, 106 sweet rolls and 100 savoury rolls a day, the gross profits would be:
|Product||Daily target||Gross profit||Gross profit margin||Daily gross profits|
As a business owner this is a useful exercise to understand what your most profitable and unprofitable products lines are. You may even decide to stop offering some unprofitable lines and concentrate on your most profitable products.
Your profit goal is the amount of money you need to meet a number of predetermined commitments that are important to both you and to the future of your business. Identifying a profit goal will help you direct your actions and strategies (once you've identified your profit drivers) to reach your target.
To set a profit goal, you will need to consider the following:
We recommend working with your business adviser to help set an appropriate profit goal for your business.
Your fixed costs (also called overhead costs) are indirect costs that stay the same regardless of your production output - this includes things like rent, utilities, maintenance costs for your work facility, licensing fees, insurance and accounting.
Your direct costs, such as labour and cost of raw materials, are only incurred when you're creating or manufacturing a product, so they're not counted as fixed costs.
When calculating your income, you should use an amount you would pay an employee to do the work you're doing. It should include superannuation, but shouldn't be an inflated salary.
Return on borrowed capital refers to an adequate return on the capital you have invested, at least equal to long term bank interest as well as an additional return based on the level of risk.
This is the return you'd expect, allowing for the associated risks - running a business has more risk than putting funds in a bank.
The return for risk should be calculated in direct proportion to the risks involved. For example, if you invested in a very speculative business venture with a low likelihood of success, you'd expect a very high rate of return if it did prove successful.
This is the amount you need to invest for future growth and development of your business. You may need to expand your premises after a few years, develop an innovative way to provide a service or new products, or develop a new marketing strategy.
To achieve your profit goal you need to calculate your minimum sales requirement. That is, you need to work out the level of sales (turnover) that will produce enough revenue to cover your operating costs plus your personal financial commitments.
Your turnover is essentially composed of:
Selling price and profit margin are key determinants of the level of sales you must achieve to generate enough revenue for your business. The higher the selling price, the lower volume of sales required (and vice-versa).
For every product you sell the money you receive will go into covering your variable costs (materials and direct labour) as well as contributing towards your fixed costs and profit goals.
The minimum sales requirement is the point where both your fixed costs and your profit goal are covered by your gross profit.
It's often useful to express the annual minimum sales requirement in terms of weekly, or even daily, units you need to sell. If your business is not capable of trading at the minimum sales requirement, then it will not be capable of meeting your profit goal.
Use the following interactive calculator to help you work out your minimum sales requirement. Once you have read and understood the example, you can type the numbers that are relevant to your business into the calculator to see your minimum sales requirement.
Profit drivers are factors that have a significant impact on your bottom line. Trading accounts and profit and loss statements usually contain information on profit drivers for a particular business, and can be extracted very easily. By identifying the profit drivers in your business and focusing on them, you can achieve the best growth results.
Profit drivers can be categorised as financial and non-financial.
Financial profit drivers are directly associated with dollar figures and are most commonly considered in relation to profit. Examples include:
A financial profit driver ratio may be expressed as a:
Data for the calculation of financial profit drivers is usually reflected in your financial statements and reports.
Non-financial profit drivers also impact your bottom line, even though they're not expressed in dollar terms. Customer satisfaction, for example, will always impact on the number of goods sold and increase or decrease profit. Bad weather may also impact sales.
Non-financial profit drivers include:
Think about your own business and the relative importance of its profit drivers. Once you have determined your profit drivers, work out why they're important to the success of your business. This will help you rank your profit drivers from most important to least important in terms of their direct impact on your business goals.
The top profit drivers common to most businesses include:
One of the most significant profit drivers is sales revenue or turnover. There are 3 simple factors that determine turnover for a business:
Use the following interactive calculator to help you work out your turnover. Once you have read and understood the example, you can type the numbers that are relevant to your business into the calculator to see your turnover.
To improve your business's turnover, you need to improve its performance in one or more of these 3 areas. You must acquire more customers or sell to them more often or increase the amount you sell to each of them.
Once you have identified and measured your key profit drivers, you should develop strategies to grow them, without increasing costs. Making your business more profitable involves looking at ways to increase sales revenue as well as decreasing your costs and benchmarking your business to see where you can save money.
You should also prioritise the strategies you've chosen to improve your profit so you can focus on the most important ones.
Once you have chosen strategies to make your business more profitable, you should prioritise them in order of importance. It's a good idea to write down your goals and the corresponding strategies to achieve them, and also how you plan to implement your strategies.
Your products or services with the highest gross profit margin are the most important to your business, as they generate more money. Once you have identified your most profitable items you should concentrate on achieving higher sales targets for them. This may require you to rethink aspects of your business or to devise strategies for improvement. Consider using a business adviser to help you.
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