Are you sure you understand profitability?

Profit bar chart, pen and calculator. Shallow DOF!

Understanding profitability should be the primary goal of all business managers. Without proper profitability the businesses will not survive in the long run. Measuring current and past profitability and forecasting future profitability is of great importance.

Profitability is measured based on revenues and expenses. Revenue is money generated from the activities of the business. For example, if crops and livestock are produced and sold, revenue is generated. However, money coming into the business from activities like borrowing money do not create revenue. This is simply a cash transaction between the business and the lender to generate cash for operating the business or buying assets.

Expenses are the cost of resources used up or consumed by the activities of the business. For example, seed corn is an expense of a farm business because it is used up in the production process. Resources, such as a machine whose useful life is more than one year are used up over a period of years. Repayment of a loan is not an expense, it is merely a cash transfer between the business and the lender.

Profitability is measured with relevant profitability KPIs: Gross Profit, EBITDA, Net Profit. This is essentially a listing of revenues and expenses during a period of time (usually a year) for the entire business. An Income Statement is traditionally used to measure profitability of the business for the past accounting period. However, a forecast income statement measures projected profitability of the business for the upcoming accounting period. A budget may be used when you want to project profitability for a particular project or a portion of a business.

Whether you are recording profitability for the past period or projecting profitability for the coming period, measuring profitability is the most important measure of the success of the business. A business that is not profitable cannot survive. Conversely, a business that is highly profitable has the ability to reward its owners with a large return on their investment.

Increasing profitability is one of the most important tasks of business managers. Managers constantly look for ways to change the business to improve profitability. These potential changes can be analyzed with forecast income statement or a Partial Budget. Partial budgeting allows you to assess the impact on profitability of a small or incremental change in the business before it is implemented.

A variety of Profitability / Decision Tools can be used to assess the financial health of a business. These ratios, created from the income statement, can be compared with industry benchmarks. Also, multi year trend for a business can be tracked to identify emerging problems.

Keeping track of your profitability KPIs doesn’t have to be a headache. There are tools and solutions available that can help you manage your performance and make smarter and more informed business decisions.

Get in touch with Wibiway team and we will be glad to support you. We are specialists in profitability, business strategy, project management and digital transformation. Our dedicated application will lead your way to track your profitability KPIs and provide you the means to steer your business to success.

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