Every business is concerned about profitability. So, how do you know just how profitable your business is? Is it possible to know what your business could make in the future? The answer to both questions is yes. Using profitability analysis, you can determine if your business is making the money it should and how well it may do in the future. It’s also a key component to determine if there are processes within your business that have problems that need to be addressed.
The Two Main Types of Profitability Analysis (and Why You Need Them Both)
When it comes to looking at the bottom line of your business, you’re looking to determine if you can be more profitable. To do this, you need to look at the two main types of profitability analysis:
- A profitability analysis involving clients. The importance of this is to look at which clients are most profitable, learn what they’re getting from your business, look for ways that you can continue to service their needs, and create an ideal client profile you can use to find more clients like them.
- A profitability analysis of your entire business model. This helps you determine where your business could do better and it allows you to forecast just how well your business may do in the future.
Performing a Client Profitability Analysis
To perform a client profitability analysis, first you must select the client or clients you’d like to include. Once you’ve chosen your client or clients, you need to decide on the amount of time that you want to use. You could opt to use a month, a quarter, or even the lifetime of their account.
Next, you should gather the information related to the revenue generated for your business. Once you have that information, you need to look at the variable costs associated with that client. This could be the cost of labor, commissions, or whatever you’ve charged the client. This data will represent the costs of the services that you’ve sold to the client.
So, now you have the revenue number for the client and you have the costs associated with the services you delivered. You can deduct the costs from the revenue to determine the profit or loss for that client.
Next, you would look at the overhead costs. These may be fixed or variable. Do not neglect to do this or your analysis will not be accurate. To make this simple, you can take your annual overhead and divide it by the actual or projected total revenue. Then, multiply that result by the revenue from the client. Take the final number and subtract it from the profit or loss number that we mentioned earlier.
You’ll learn a lot about your business by performing this type of profitability analysis.
Looking at the Profitability of Your Business Model
Now that you know how to perform a client profitability analysis, let’s look at some ways you can analyze the profitability of your business model. First, you can look at your net profit margin. This number gives you a big picture look at how your business is doing. Make sure that you know what profitability margin is good for your particular industry.
You can also run a comparative expense analysis if you think that your business expenses may be going up. However, you’re going to need at least two years of data to do this. If you have accounting software, use it because doing this long-hand can result in errors.
Finally, look at your profit by segment. We’re sure you’ve heard of the Pareto Principle (known as the 80/20 Rule). It expresses that 80% of your profit comes from 20% of your work. Segment out your business by service and look at which area has the best revenue and net income.
Using the Data
Once you’ve calculated the data from your profitability analysis, use it. Look for both positive and negative trends. Capitalize on the positive trends. Look at the negative trends and examine how you can repair those areas of your business.
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