As a small business owner, you always have a million-and-one things to think about. It can be difficult to stay on top of the numbers and know which ones matter when it comes to the financial health of your business. However, it’s essential that you know whether you’re operating at a profit or not. Burying your head in the sand is never a good solution. Instead, you need actionable data that will allow you to stay on track and strengthen your business. Even if things are going well, there’s always room for improvement. Here’s how to work out whether or not your small business is profitable.
Net Profit Margin
In order to determine profitability you need to calculate your net profit. Fortunately, this is easy to do – so long as you have been maintaining accurate records. The equation is as follows:
Revenue – Expenses = Profit
If your answer is positive, then you’re turning a profit. If it’s negative, then you’re losing money.
Net profit refers to the amount of money you keep after paying taxes and interest on debt, as well as business expenses. Therefore, you must include those numbers in your calculation.
Remember that turnover doesn’t tell the whole story. For example, a business that makes £100,000 per year and spends £20,000 on expenses has a net profit of £80,000. However, a business that makes £150,000 but spends £160,000 has actually lost £10,000, despite having a larger revenue.
You should review your net profit margin more than once per year. We recommend performing a monthly analysis so that you can monitor how your profit margins are changing and spot seasonal trends, too. This will prove enormously helpful in predicting future profit and creating a realistic business budget. It’s also important to be aware when your profit margin is decreasing so that you can take action before it’s too late.
Gross Profit Margin
Gross profit margin is another important indicator of profitability for your small business, especially if you sell physical products rather than provide services. You calculate gross profit as follows:
Sales Revenue – Cost of Goods Sold = Gross Profit
Gross profit differs from net profit, though many confuse the two. Gross profit refers to the percentage of profit you keep after the cost of goods sold, whereas net profit includes other costs such as tax and interest paid on debt.
Again, it’s important to review this on a monthly basis and compare your gross and net profit. This can help you to identify areas of improvement or concern. If your gross profit margin remains healthy but your net profit is decreasing then product cost isn’t your problem and you need to look closely at your overheads, taxes and debts.
Operating Expenses
If your revenue is increasing but your profit margins are decreasing then you need to take a look at your expenses. It’s easy for expenses to outpace revenue as your business grows, so you must keep a close eye on these numbers to ensure that you remain profitable. Some expenses, such as new equipment and employees, are unavoidable during a period of growth but be sure to review your costs regularly and look for areas where you may be able to save.
Profit Per Client
Some clients generate more profit than others for your business, and it’s in your best interests to identify these clients. The answers may not always be obvious: the clients who pay the most in fees may have a poor revenue to expenses ratio. So how do you work out profit per client?
First, take the total project fees and subtract all project expenses to calculate the gross profit of a client project. Then, divide this time by the total number of hours worked on said project to calculate the hourly rate. This will provide you with actionable data to help you identify the most lucrative clients and projects going forward.
Summary
As a small business owner, regularly reviewing and analysing your numbers will provide you with valuable data that you can leverage to become or remain profitable. In order to improve your business, you must first get clear on your current reality. If you want to increase profitability, it’s time to start crunching those numbers.