In the world of running a business, making a profit isn't just nice to have—it's essential.
While most business owners understand the importance of making a profit, not everyone understands what it is and what they can do to influence it.
Profit is the result of what we do every day in our business. It tells a story about our business's financial health and operational efficiency.
To really make a difference in our profit, we need to look at what we're doing—our daily activities, how we spend money, and how we make decisions.
Gross Profit - The First Glimpse of Profitability
Gross Profit is the first look at how well a business is doing at making money from what it sells. It is calculated as total sales less direct costs.
Direct costs are all the expenses incurred in producing our products or services – labour, materials, subcontractors, vehicles, etc
Each month, make sure that you track your main direct expenses as a % of sales. This will quickly identify any issues that you need to dive deeper into.
I work with a trucking company whose main direct costs are drivers (labour) and truck costs (fuel, RUC’s, R&M, etc). We always measure these as a % of sales. Why? Because any change in the % tells a story that we need to investigate. We may have productivity issues, or an older truck may be costing too much in R&M, or our pricing for a large customer may not be right.
EBIT - The Heartbeat of your Operations
EBIT (Earnings before interest and tax) is the operating profit of your business. It is calculated by deducting operating expenses from your Gross Profit.
Operating expenses are the costs that you incur irrespective of how much you sell. For example, rent, insurance, utilities, indirect wages, etc. These costs remain the same each month and are the base costs that the business must cover.
Understanding this number is crucial as it tells you if the business operations are profitable.
Net Profit - The True Measure of Business Success
Net Profit, often referred to as the bottom line, is what remains after interest and taxes have been deducted from EBIT.
The difference between EBIT and Net Profit is how a company has been funded. If there are interest costs, then a company is funded by loans and/or an overdraft.
Cash Profit - The Reality Check
Cash Profit is all about the cash that's actually moving in and out of your business.
It adjusts Net Profit by adding back non-cash expenses like depreciation and deducting cash expenses not included in your Net Profit, like loan principal repayments and owners’ drawings.
This to me, is the number one measure!
Many businesses have a Net Profit, but their cash profit is negative, meaning that they can’t afford their loan repayments and drawings.
Before taking on loans, you should always look at your ability to repay them. Do not borrow, if you can’t repay! First improve the operational efficiency of your business.
As a business owner, you should only have drawings if you are not paying yourself a PAYE wage. And these drawings should be equal to the wage that you would get if you were employed by another company. Any more and you are bleeding your company dry!
The company can’t sustain a negative cash profit, and it is called ‘Growing Broke’. ☹
Making a Difference in Your Profit
To really make a difference in your profit, you need to look at four main things:
People: The team working in your business can make a huge difference. An engaged, efficient team can help get more work done without increasing costs. Helping people play to their strengths, reviewing the way things are being done, hiring talented staff that share your values, setting clear expectations and celebrating success are all ways to engage your team, which will lead to efficiency.
Costs: Keeping an eye on what you spend is key. When was the last time you price checked a supplier? What is the $ value of sales you are getting from your marketing spend? Do you need the insurance cover that you are paying for? Are you holding too much stock? Do you need all the subscriptions that you are paying for? Each year, review your expenses line by line to determine if they stay or go.
Pricing: Setting the right price is important. Understanding the profitability of each product or service will allow you to set a price that makes you money. Now, benchmark your prices against your competitors. If you are slightly higher, what are you offering your customer that will making paying a higher price a no brainer? If you can’t charge that higher price, how can you reduce the costs of making that product or service?
Customers: Often business owners will look to increase prices or sell more to increase profit. Whilst this will have an impact, I urge you to look deeper into your customers. Who are your ideal customers? Why? Are there any clients that we are spending a lot of time and effort servicing? For example, they want the full service, but only willing to pay the ‘nuts and cola’ price. The old adage of ‘less is more’ will actually improve our profitability if the ‘less’ is more ideal customers.
Please remember, you don't need to be an accountant to understand your numbers. You just need to consistently track your numbers and ask questions to understand them.
Each month:
Run a profit and loss statement from your accounting system and look at the different profits.
In a spreadsheet, list 5-6 key metrics that you want to measure, and start to track these. Over time you will see a pattern; any deviances will need to be investigated to understand why.
Implement 1-3 small changes in your business that will improve your profit.
Every little bit helps, and it's these smart choices that can lead to a big difference in your profit.
If you are willing to put in the time and effort required to learn and implement strategies that will help your business achieve profitability, get in touch!
I’ll set up a zoom and get to know more about your business!
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