What Your Numbers Are Saying: Are You Listening?
Part 1: Do You Know Your Profitability?

When evaluating the financial health of your business, it’s important to look at a variety of indicators – but how can you be sure you have the right numbers? Are you as profitable as you could be? How do you compare with industry peers?

Finding answers to these questions is often difficult for business owners, who may not have a clear picture of their financial health because they don’t have accurate financials or a CPA who can show them what the numbers really mean. A superficial understanding of cash flow and profitability is not enough for effective strategic planning and decision making.

For a deeper look at your financial health, here’s what you need to know.

Profitability Analysis: Start with Cash Flow

While your bank balance may look healthy, it can’t tell you whether your organization is as profitable as it could be.

Understanding profitability starts with an analysis of cash flow. Accurate financials help you understand your profitability today while forecasting the revenues, costs and net cash flow that reveal what profitability will look like tomorrow—and what you should do with what’s in your bank account today. Considerations include how much cash should be…

• Retained to cover future shortfalls
• Invested in hiring, equipment, expansion, and growth in general
• Used to pay down debt (and when)
• Distributed to employees and ownership/shareholders

Know Your Margins

Grossing $20 million in revenue is great but not if only $10,000 of it reaches your bottom line. That is why a crucial part of an effective profitability analysis includes a review of the following margins:

Gross Profit Margin

This is the amount of your sales revenue less the true cost of your goods (or services).

Net Profit Margin

Net profit as a percentage of your revenue provides indicates if you are generating a healthy profit from your sales and if you are keeping operating costs and overhead in check.

Segmented Profit Margins

Most businesses offer more than one product or service and may have multiple locations or departments, so it’s important to “segment” these revenue streams to understand their profitability.

Client Profitability Examples

One of our professional services clients was having a good year so they increased employee compensation significantly. While beneficial for employee retention, our client did not have an accurate view of how much profit reached the bottom line. We were able to show them the numbers needed to determine when they could continue increasing employee compensation, when to dip into their credit line, and how better payment terms could be obtained.

After performing an inventory analysis, we determined that one of our manufacturing clients had too much inventory. They knew their gross revenues but not how much inventory was costing with labor and overhead factored in. As a result, too much capital was tied up in inventory. Now they know what their target gross margin is, when they need to charge more, how profitability breaks down by product line, and how much inventory to keep on hand to maximize profitability.

Get Started Today

If you could use a better grasp of what’s driving your profitability (or lack thereof), let’s talk. Get started by taking advantage of our complimentary Profitability Analysis, which will evaluate your company’s performance and how it compares with your industry peers.

Contact us to learn more about our accounting advisory services

 
Related blog:

What Your Numbers Are Saying: Are You Listening?
Part 2: How Attractive Is Your Balance Sheet?