How Profitability Analysis Helps Businesses Understand Financial Performance
You run a business. Sales are coming in, and it can be easy to assume that since you can pay your bills, you’re in good financial health. But that may not be the case. A profitability analysis can provide some answers and help you better identify:
- Trends in your business
- Operational inefficiencies
- Growth opportunities
Once you dissect your analysis, you can integrate profitability strategies and start working on improving your bottom line.
What is Profitability Analysis?
Businesses have two components that take center stage in an analysis:
- Revenue streams
- Costs
Revenue and costs dictate your company’s ability to earn a profit. A profitability analysis looks at both of these components in great detail, providing insights into the profitability of different business units, each product you sell, locations and other data.
Depending on the type of business you operate, it may make more sense to have a customer profitability analysis that provides insights into your specific customers or even a segment of them.
Your analysis provides qualitative data that you can use to better understand your business’s strengths and weaknesses so that you can accurately allot resources to reach your growth KPIs.
What are the Key Components of Profitability Analysis?
Profitability analysis is part of a business’s larger resource planning and identifies ways that you can make each project or product more profitable.
Profitability Ratios
Multiple profitability ratios are provided in an analysis to help owners know how a business generates revenue in relation to its equity, assets and costs over time. Profitability ratios may include:
- Operating profit margins
- Return on equity
- Return on assets
If you have a 1.5% or higher operating profitability ratio, this is considered good.
Break-even Analysis
Is your business profitable? If not, a break-even analysis will outline at which point your business will be profitable. You’ll learn at exactly which point you’ll generate enough revenue to cover your:
- Fixed costs (i.e. rent, utilities, salaries, etc.)
- Variable costs (materials, etc.)
The break-even analysis shows the minimum sales you must make to break-even. Additional sales beyond this point will be where profitability starts.
Qualitative Analysis
Qualitative data from SWOT analyses, surveys, focus groups and market research can also be incorporated into your profitability analysis. Why is this data important? It provides insights into market trends and customer preferences that may influence your business’s profitability.
Customer Profitability Analysis
How profitable are your customers? Are some generating significantly more profit than others? Analyzing customer profitability will help you compare the profits brought in by customers to the cost of selling to them.
Once you have a better understanding of which customers are contributing the most or least to your profits, you can better allocate your resources and maximize the potential of the most profitable customers.
Why Should You Perform Profitability Analysis?
To Find Growth Opportunities
Which areas of your business contribute the most to your profits? A profitability analysis will provide some insight and help you identify opportunities for growth.
For example, your analysis may show that some products are significantly more profitable than others. With this in mind, you can allocate more resources toward marketing and developing these products.
For products that are least profitable, you might decide to remove them entirely.
By focusing on your most profitable products and growth opportunities, you can improve your profitability over time.
To Maximize Your Business’s Assets
Your assets help you generate revenue and profit, but are you maximizing their potential? Profitability analysis can answer this question.
The data from your analysis can help you find ways to use your assets more intelligently and maintain them efficiently.
To Monitor Your Performance
When you conduct a profitability analysis regularly, you can spot trends over time and make adjustments to continually improve your performance. That historical data can also be used to help you make smarter and more impactful decisions.
To Improve Your Products or Services
Profitability analysis can empower you to optimize and improve your products or services. How? By helping you identify which of your offerings will generate the highest profits and which ones are the least cost-efficient.
For service providers, profitability analysis can help you identify which accounts are contributing most to your bottom line.
With this data in mind, you can make improvements and play on your strengths to improve your profitability.
Closing Thoughts
Every business should leverage profitability analysis to understand which areas are driving the most profit, identify areas to cut costs and pinpoint offerings that are costing more than they’re worth.
Unfortunately, many business owners skip this important step because, let’s face it, performing a profitability analysis is complicated. The good news? An accounting professional can handle this difficult task for you.
To learn more about improving your business’s profitability or how we can help you with your accounting needs, schedule a consultation now!
