
Do You Really Know How Profitable Your Business Is?
Aug 30, 2024
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As I meet with small business owners, a common theme is a need for clarification in calculating profitability for their business.
Before you read ahead, I want you to reflect on your understanding of what it means to be profitable: What does it mean to you? How do you understand it?
Okay, continue.
Profit is the money a business makes after subtracting all expenses from its revenue. It's crucial for covering costs, enabling growth, and creating strategies to achieve business objectives and goals for sustainable growth.
There are three types of profit: Gross Profit, Operating Profit, and Net Profit. Each measures different parts of the business. The following includes education, an example, reflection questions, and instructions on how you can calculate profit for your business.
Gross Profit
Gross profit measures the profitability of a specific product or service, not overall business performance. Gross Profit helps identify areas for improvement in production or cost optimization. Gross Profit is all about efficiency in the production of the product or delivery of the service. It represents the profit before subtracting operating expenses and other indirect costs.
How to calculate:
Gross Profit = Revenues - COGS*
*COGS = Cost of Goods Sold
Operating Profit
Operating profit shows how well a business is doing in its day-to-day operations. It includes all operating expenses like rent, payroll, advertising, and utilities. When the operating profit is positive, the business makes money from its regular operations. It also helps to see if the business is efficient and managing costs well. A positive operating profit means the business can cover its ongoing expenses and is sustainable. It's also used to see if the business can grow.
How to calculate:
Gross Profit = Sales - COGS (or cost of sales)
Operating Profit = Sales - COGS - Operating Expenses - Depreciation and Amortization
Net Profit
Net profit is a business's final profit figure after accounting for all costs, including interest and taxes. It's often referred to as the "bottom line" and represents the overall financial health of the business. A consistently positive net profit is crucial for financial stability and growth. It's the ultimate measure of a business's profitability and essential for financial planning and decision-making.
How to calculate:
Net Profit = Operating Profit (EBIT*) - Interest Expense - Taxes
*EBIT = Earnings Before Interest and Taxes
Let’s Walk Through an Example
Murphy sells cookies for $15 a dozen. Last week, Murphy sold 20 dozen cookies. Each dozen costs $8 to make.
$ 300 Sales ($15 * 20 dozen)
- 160 COGS (costs $8 * 20 dozen)
$ 140 Gross Profit
Murphy’s operating expenses are $110.
$ 140 Gross Profit
- 110 Operating expenses (cookie boxes, marketing materials, paycheck, etc.)
$ 30 Operating Profit
Murphy’s tax rate is 20%.
$ 30 Operating Profit
- 6 Taxes ($30 * 20%)
$ 24 Net Profit*
*Murphy will decide how to use the net profit - like reinvesting in the business, giving out quarterly bonuses, or putting it into savings.
Reflection Questions
What is something new you learned about profitability?
How does this new knowledge apply to your financial situation?
What is something you can do to make progress? Need help? Check out the next section - I got you! ;)
Calculate Your Profit
Gross Profit
What specific costs are included in your business’s gross profit calculation?
How can you optimize your production process or cost of revenue to increase gross profit?
Operating Profit
Which operating expenses impact your business’s operating profit (rent, marketing,etc.)?
How can you manage these expenses effectively to enhance profitability (lower costs)?
Net Profit
What other income streams or cash flows affect your net profit?
How can you minimize negative cash flows (such as interest and taxes) to maximize net profit?
Financial coaching is more than learning a financial concept. It’s about applying it to your specific financial situation, planning the right actions to achieve your goals, and being committed to making positive changes.
I’d love to help. Join my email list. Schedule a 20-minute Q&A call. Talk to someone you trust. Just do something. :)
Jessica