How To Determine And Track Business Profitability

The answer to the question “Is your business profitable?” seems like it should be obvious from a quick look at the checkbook or a nod from an accountant. As counterintuitive as it is, small business owners are sometimes among the last to realize that their businesses are unprofitable. Often preoccupied by the necessary endeavors of securing new business, servicing existing customers, developing partnerships, and paying bills—in other words, keeping the business operating on a day-to-day basis, busy entrepreneurs frequently overlook the practices and procedures for ensuring profitability.

Tracking profitability involves more than finding a positive balance in the checkbook. Fortunately, establishing a system to track and measure profits need not be time-consuming or difficult, and it can save you hours of work, and worrying, down the road. The challenge is two-fold: running your business in a way that helps maximize profits, and measuring your effectiveness.

First, it is important to identify the barriers that typically prevent entrepreneurs from developing systems that monitor profitability. Here are three of the most common:

  1. Securing new business is an overriding priority. Especially in the initial stages of a business, building a customer base is usually the highest priority. This can have a significant short-term impact, as businesses spend a lot of money on promotion and offer special margin-eroding incentives to lure new customers. You need a plan that can help you quickly identify trends in customer behavior and sales, to help focus promotions on just those features or products that need help, and not provide discounts or giveaways that may be unnecessary.
  2. Existing customers require too much attention. If you find yourself stretched too thin because of customers’ needs, it’s time to consider adding to your existing team, allowing you to devote more time to the needs of the business. Unless you are aware of your financial situation, or have access to critical data, it may be difficult to know whether you can afford to hire additional staff.
  3. To compete effectively, you must establish and develop strong partnerships in your supply chain. As with customer acquisition, many business owners make financial sacrifices in the early stages of growth for the sake of establishing necessary supplier and vendor partnerships. It can be tempting to commit to long-term, high-quantity contracts to ensure availability of key items for your business. Know where your money is going, and develop a plan for renegotiating contracts and pricing with vendors.

Aside from these behavioral matters, here are some basic operational issues to focus on as you become more adept at maximizing profits.

Sales Practices

Are you “leaving money on the table”? If you or your sales force typically sell on price or negotiate unprofitable terms with customers for the sake of the sale, you are setting yourself up for profit problems. Establish clear sales goals and objectives that reflect your profit goals. Be specific about when and how pricing and terms can be negotiated.

Furthermore, if your marketing initiatives and promotions are price-based, you should have systems in place to track the effectiveness of these campaigns. If the results are not significant (that is, not profitable), consider other strategies.

Pricing

Are you including administrative and other business costs in the prices of your products, over and above your actual cost and markup? When selling a product or service in any industry, it is important to factor in what it costs to sell your product or service. You must amortize your real estate, payroll, insurance, and other fixed costs, and these must be figured into your pricing model. You should also consider how your pricing compares to that of your competition, as well as how your market will respond.

Once you take these factors into account, you may find that your mix of products and services can be changed. Altering the mix of products or services to offer price incentives on higher-margin items (while offering lower-margin items at full-price) is one recommended strategy.

Additional Barriers to Profitability

Accounts Receivable – Another common problem and barrier to profitability is the management of accounts receivable. While most business owners will agree that being a “collection agent” is NOT why they started their own business, difficulties collecting on products shipped or services performed are a fact of life. Establish your payment terms up-front, and be very clear about your expectations. Create a standard billing and collection schedule, and train your accounting staff to handle these tasks for you.

Purchasing – As previously stated, there are inevitable costs associated with the acquisition of raw materials, parts, or supplies from vendors. You should regularly review your contracts and pricing agreements to be certain your purchasing practices reflect the profit goals of the business, and share your goals and expectations with employees who may be responsible for purchasing.