Profitable small businesses do things in certain ways that lead to success. They know how to adapt to situations, have clear objectives and have ways to measure profitability. Your company may see an increase in sales, but this might be fool’s gold. You might be overlooking a blip in the market. That’s why it’s important to identify metrics that determine profitability.
Here are ways you can measure small business profitability.
Net Profit Margin
It is possible to start a small business with little capital. However, once your sales have stabilised and have tapped into a specific niche, you will need measures of success to keep your company going. One of the metrics you can use is the net profit margin ratio. You get this ratio by subtracting all company expenses from revenue, then dividing it (net profit) with total revenue then multiplying by 100.
The net profit margin ratio shows the financial health of your small business. Monitor increases or decreases in this ratio each month within a fiscal year. The fluctuations provide you with information, if you need to adjust your operations’ strategy.
Gross Profit Margin
This metric shows the gross profit you made in relation to net sales. You compute this ratio by dividing the difference of net sales and the cost of goods sold with net sales. This metric shows that your company has the financial means to pay for operational costs and maintain enough funds for growth. It also indicates where your cash goes whether it is for purchasing materials to make products or paying for the needs of operations.
Break-Even Analysis
Profitable small businesses use break-even analysis as a metric for success. This shows if your business costs are higher than your revenue before breaking even. You will know if your company is making money when revenues are higher than costs after crossing the break-even mark. Identifying this point enables you to identify the adjustments you need to make to generate a profit for each product or service you sell. You get the break-even point for sales when you get the sum of fixed and variable expenses.
Operating Profit Margin
This metric provides you with details about how available revenues can pay for interest and other non-operating costs your business incurs. This allows you to determine the riskiness of your company. This ratio is a reflection of your small business’ efficiency and management. The formula for this metric is operating earnings (earnings before interest) divided by revenue.
The profitability metrics mentioned above allow you to determine if your small business will not only survive, but also thrive in your niche. Consider Robookkeeper’s small business accounting services to keep your books updated.
