Have you ever watched a hamster run around its wheel? Lots of effort. Not a lot of progress. And very tiring! While revenue is important and feels good as your business grows in sales and customer outreach, you want to be sure that you focus on profitability.
Increasing revenue is often a necessary step to increasing profitability, but increasing revenue, by itself, is not enough. In order to ensure that your company’s sales efforts generate higher profits as well, it is critical to understand fundamental aspects of your pricing, variable vs. fixed costs, and other factors.
Profit vs Revenue: Which is most important to your business?
You probably understand the meaning of profit and revenue if you are a business owner. Both are essential aspects of your business’s financial success, but what should you focus on to grow your business?
What is Revenue?
Revenue is the “top-line” sales generated from your business activity, whether products or services. For products, revenue is the average sales price times units sold (formula: product price x units sold = revenue). For services, then it is the total amount of money generated from the services.
An increase in revenue seems like the dream—customers are buying your products/services, your business sales increase, and you might think your business automatically is making a lot of money.
However, revenue is just one part of your business’s financial profile.
What is Profit?
Profit is the “bottom-line” earnings and money you have remaining from your business sales (products/services) after paying the expenses, taxes, and other costs. Costs may include labor (salaried or hourly), machinery, raw materials, and more.
Simply, this is the formula of profitability:
Profit = Revenue – Expenses
Let’s take a simple example: Bob has a manufacturing company that produces furniture and fixtures for commercial properties and offices. Bob’s company generates $500,000 in sales (or revenue). However, the costs, including hourly labor staff within the production department to handle machinery, the raw materials needed to create the furniture, and the facility rental lease, cost Bob $200,000 for the year. After deducting the expenses from the revenue, his company has earned $300,000 in profit.
What Parts of My Business are (Un)Profitable?
Calculating profit can be more complicated than it may appear, but having someone specializing in accounting and financial analysis ensures that your company has high-quality information that can be used to make high-quality financial decisions.
Knowing which parts of your business are profitable (or unprofitable) is critically important to understanding your business, and its success path, as a whole. While most business owners know whether the company is profitable or not, in many cases it may not be clear which elements of the business are contributing to its success – or holding it back from further growth.
The sometimes underappreciated tool that can be used to determine and understand the true profit drivers within your business? Segment profitability analysis.
What is Segment Profitability Analysis?
Segment profitability involves an assessment of profitability that is broken down into groups – products, services, customers, divisions, locations, or however else the business may be evaluated. A segment profitability analysis allows your business to see if certain customers are adding or costing your company money. Or if a certain store is more profitable than another. Or if a new service line just isn’t pulling its weight.
Advertising and marketing campaigns are expensive. Payroll is a major expense for most every company as well. If these financial and human resources are not deployed optimally within your company, then you almost certainly are leaving money on the table. A well-prepared segment profitability analysis can define which business segments to focus on for improvement, for further growth, or for elimination – so that you aren’t just a hamster running in circles on its wheel!
The Real Question: How Can I Increase My Profitability?
In order to increase your business’s profitability, there are many factors to consider, including cost management, pricing strategy, operational efficiency, revenue growth, etc.
You might ask yourself the following questions:
- Is our pricing strategy maximizing profitability?
- Do we have the optimal customer/product mix to drive company value?
- Do we truly understand our profit margins for each segment of our business?
- Are we utilizing systems and technology efficiently to maximize output?
- Do we have operating processes that could efficiently save time and expenses?
- Are there costs we need to reevaluate or reconsider?
While lowering costs and increasing prices is tempting to maximize profit margins, it is important not to compromise on quality or price yourself out of the market. Lowering costs can hurt the quality and operations of your business, whether from inferior raw materials or from inefficient tools and systems. And prices should be competitive in the market, or they may discourage customers from buying your products or services.
How Can We Help?
Sabre Financial Group offers CFO and Controller services for small to medium-sized businesses in many industries on a fractional or interim basis. We can conduct segment probability and other financial analysis to help you understand the true profitability dynamics of your business.
We tailor our services to your individual needs so your business can grow and thrive. Please contact us to schedule a consultation with our team so we can help to drive growth – with profitability! – throughout all aspects and segments of your business.