|Are you making money?|
And even though my goal here is not to make a treaty about business’ profitability from a theoretical point of view, since it’s not my professional area, as an entrepreneur I’ve been, I already know it's extremely important to understand the meaning of "business’ profitability" in order to properly manage yours and make sound decisions, at the right time.
Having made this clarification, I want to review with you some ideas about "profit" because it often happens that “profitability” is mixed and confused with earnings, successful, billing volumes, and so forth, and all this leads many entrepreneurs to pursue really good goals that have been set in not the best possible way.
Let's get back to the beginning: What does "profitable" mean?
According to the Dictionary:
"Profitable" means "producing sufficient income or being rewarding" and "rewarding" refers to something that "is generating profits, satisfaction”. And according to Wikipedia, the "Profitability" is the ability to produce or generate additional benefits on an specific investment or effort.
If you notice, the definition is very simple: A profitable business is one that produces profit. And it will be more or less profitable, depending if it generates more or less profits based on the money or effort you’ve invested or put into it.
Now: How can your understanding of “Profitability” lead to confusion.
Let’s talk about a big company with a million dollar payroll, hundreds of employees, spacious offices, yearly billings of 200 million euros, has about 175 million in expenses and has generated a 25 million euros net profit. Not bad, right? Those figures are very interesting, great, awesome.
Let’s compare it then with a small, local company with yearly billings of 150,000 euros, expenses in the order of 100K and generates only 50K €profit a year.
Which one would you consider the successful one? Which one would you perceive as the most profitable?
At first glance, you could be strongly impressed by big figures and an annual profit of 25 million euros. And they really are impressive, but they represent a return of only 14%.
How to calculate this percentage?: just take the profit earned, then divide it by their costs and multiply it by one hundred. If you do the same calculation for the small local business, what do you get as a result?
It turns out that the small local business, with tiny numbers, has a profitability of 40%. Almost three times that of the big business!
What does it mean to your business?
First of all, big figures can give you a false illusion about your business: The fact it has millions on billings, doesn’t necessarily represent a successful and profitable business.
Second, your business will be more or less profitable, as it produces profit, nothing more than that. Your business’ size, the number of employees you have, the square footage your offices occupy, doesn’t make any difference at all
It is about numbers and nothing else, and it can be calculated on a simple way:
- Calculate your total sales in a specific period.
- Add up all the money you spent running your business during the same period of time.
- Subtract your expenses from your total sales to get your net profit.
- Divide your net profit by your total expenses, multiply it by one hundred, and that is the profitability rate of your business, in a very simple and domestic way.
Some time ago I published an article in which I said businesses should be driven by numbers and not emotions. The amount of effort you put in, the many hours you work, all the ideas you get going, everything you do is only justified and makes sense when your business is profitable, and not otherwise.
Do not fall prey to the illusion of numbers, size or appearance. Even the smallest business can be extremely profitable, if the numbers are managed properly.
Remember that a business is more profitable not because it has the largest billings, but because it generates more profits.
Related article: Charging the Right Price: The Single Most Important Rule of Business