Making a profit is essential for business longevity. Profit can give a business the funds to take advantage of new opportunities and invest in new ventures. A business that is not profitable is not able to grow and expand, or move forward.
Read on for some profit terminology and formulas, and also some tips for improving profitability in your SME.
Definitions / terminology
Like many things in business, there are a lot of specific terms that surround profitability.
- Gross profit = sales revenue less the cost of goods sold (COGS). So if sales revenue for the week was $1,000 and COGS $600, gross profit would be $400.
- Net profit = gross profit less overheads or running costs. Using the above example, if overheads were $100, net profit would be $300.
- Profit margin = gross profit divided by sales revenue x 100. Using the above figures, profit margin would be 40%.
- Breakeven / minimum sales point = overheads divided by price minus COGS. This formula calculates the minimum number of sales of an item you would need to make just to break even. So assuming overheads of $100, a unit price of $10 and cost of $5, the breakeven point would be 20. This means you would need to sell 20 of those items to break even, and more than 20 to make a profit.
Strategies for improving profitability
Essentially, improving profitability can be done by increasing prices, improving productivity, changing marketing strategies, and / or decreasing costs.
1. Review prices:
This can be done by calculating the profitability of individual items and re-setting your prices to meet your desired profit margin, using the formulas above. It can also be used to show which of your products are the most profitable and give you the option to focus and promote those and maybe scale back on less profitable items.
2. Review sales volumes:
No matter the profit margin on your products, if you don’t sell enough of them, you won’t make a profit.
In this case, you can use the breakeven formula to calculate how many units of your product you need to sell to make a profit. If you find your sales volume is too low, consider the following:
- Increasing the price.
- Reducing the costs.
- Offering temporary discounts or special deals to get the product moving.
- Reviewing and altering your marketing strategies.
3. Improve productivity:
There are a number of ways to improve productivity, including:
- Work in 90-minute blocks. Research at Florida State University showed that productivity starts to decline after 90 minutes.
- Avoid multi-tasking, as it tends to increase fatigue.
- Take regular breaks from work, and also provide proper breaks for workers.
- Run a training analysis to identify skills gaps and invest in staff training and development. This has been shown to improve job satisfaction and retention.
- Provide a healthy workplace in terms of design, lighting, safety and indoor air quality.
- Use technology to improve efficiency and save time. This might include virtual meeting software, programs to synch data across multiple devices, and moving your business to the cloud for file share, project collaboration and other activities.
4. Reduce costs:
Examine your work practices to see where you might be able to reduce costs. Examples include:
- Reduce inventory levels, particularly of slow-moving items.
- Buy in bulk to save costs – although this is only likely to be beneficial for faster-selling items.
- Consider changing suppliers to get a better deal.
- Take steps to reduce overheads. This might include using energy more efficiently, and ditching some of the old machinery and equipment such as fax machines and printers and replacing them with more efficient, multifunction systems.
- Make use of cloud programs such as cloud accounting, online fax and online file storage. As well as saving time this can save on the cost of paper, toner, and electricity, and on the space required for physical files.
This is a brief overview of the ways you can improve profitability in your business, but it should at least give you some pointers for getting started!
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