Measuring Your Business Profitability
Financial Strategies for Women Business Owners
In this four-part series, we’re going to look at the critical metrics your business needs to track in key areas:
profitability, liquidity, efficiency and customer acquisition/satisfaction.
First up is a look at profitability metrics. As with all the other areas, there are dozens of possible metrics you could track, but we’re going to focus on four of the most important ones, and look in detail at how you calculate them, what the results can tell you about the health of your business, and most importantly, what action you can take to improve your results in the future.
A lot of the numbers we’re looking at in this tutorial will come from your company’s income statement.
1.- Gross Profit Margin
Why It’s Important
This number is a good basic measure of how efficient your company is at manufacturing and distributing its products. It helps you zero in on your costs, and how much they’re eating into your profits.
How to Calculate It
The formula for this one is quite simple:
Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue
2.- Return on Invested Capital
Why It’s Important
One of the most basic things that companies do is to take money that’s been invested (capital), and turn it into profit. Return on Invested Capital is a measure of how effectively your company is doing that, and so it’s crucial to keep track of.
How to Calculate It
Working out ROIC can be either very simple or very complicated, depending on how much detail you want to go into.
Let’s look at the simple method first. The simplified formula is:
ROIC = Net income / (Long-Term Debt + Equity)
These are all numbers you can find easily on your business’s financial statements. Net income is the “bottom line” number on the income statement, and total debt and equity are on the balance sheet.
3.- Overhead Ratio
Why It’s Important
Overhead costs can be a real drag on a business’s profitability. If you’re spending a big portion of your income just keeping the lights on, you’ll struggle to grow. We looked at costs associated with sales in the “gross profit margin” section, and this is the other piece of the puzzle: fixed overheads.
How to Calculate It
You can calculate your overhead ratio using the following formula:
Overhead Ratio = Operating Expenses / (Operating Income + Interest Income)
Again, these are all lines from the income statement. Operating expenses are the “overheads,” things like office rent, utilities, machinery maintenance and so on. They’re necessary for your business, but they don’t directly generate income.
4.- Asset Turnover
Why It’s Important
There are different ways of making money. Some businesses, like Walmart and other discount retailers, have low profit margins but a high volume of sales. Asset turnover measures how efficiently your business uses its assets to generate sales.
How to Calculate It
This is a nice simple one to end with. It’s simply:
Asset Turnover = Total Revenue / Total Assets
Your revenue number, of course, is the top line from your income statement. It’s the total amount of sales you brought in over the year. Total assets are just the sum of all your property, equipment, inventory and so on, and you can get that number straight from the balance sheet.
Next Steps
If you look at one of these metrics on its own, it’s of limited use. Take them all together, and you have a clear picture of your business’s profitability.
You have now learned what these metrics are and how to calculate them, and what the results tell you about the health of your business.
Source: Business
Patty Block, President and Founder of The Block Group, established her company to advocate for women-owned businesses, helping them position their companies for strategic growth. Charting the course for impactful, sustainable, profitable businesses, the beacon is control: of your strategic direction, your money, your time, your staffing, and your ability to bring in business. The Block Group brings together the people, resources and ideas that build results.
Growth strategies for small business.
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