Entrepreneurs start businesses for various reasons. For example, some of them open a company so that they can pursue their passion. Others do it because they have some spare time. However, the primary reason why entrepreneurs start businesses is to gain profit. This profit sustains them and their families. It is also a source of capital for the business. More
specifically, the entrepreneur can reinvest his profit into the company
instead of seeking loans from banks. Furthermore, profit is essential because it is a source of morale for your staff. Consequently, the assessment of business profitability is critical because everyone wants to know how profitable you are including your employees and investors.
Calculating Your Net Profit
The concept behind this calculation is simple i.e. total revenue minus total expenses. The first thing you ought to do is to look at the total revenue you raked in during the year. Then subtract the cost of the goods you sold to get your gross profit.
Calculate the sum of your operating expenses. There are two types of expenses i.e. fixed and variable expenses. The former includes items such as rent, license fees, and insurance. The latter includes advertising costs and delivery charges. Add them up and then subtract them from your gross profit.
Then you should examine the interest you have paid to other parties such as banks in addition to the taxes you are paying to the government. Subtract this interest and taxes from your gross profit. In other words, your net profit is gross profit minus your expenses, taxes, and interest payable.
The resultant figure should tell you if your level of profit is where you want it to be. More specifically, it should cater to your personal obligations. However, catering to some of your obligations is acceptable if you have another source of household income.
You may be making a bit of profit, but other similar businesses may be making huge profits. You have to improve your business model if that is the case. That means an assessment of business profitability has to be comparative as well. In other words, looking at your net profit alone is not enough. Instead, you have to compare it with the profit other businesses are making. You can introduce new products, reduce your expenses, or hire talented staff if other firms are outshining yours. Conversely, you can think about buying out other companies if you are doing better than they are doing.
Challenges in Assessing the Profitability of Your Business
The assessment of business profitability depends heavily on the accounting professionals you hire and the accounting methods they choose. Your accountant should prepare your financial records accurately and in a timely fashion. Remember, you will use the data contained in these records to calculate your profitability. That means your trial balance, income statement, and balance sheet has to be accurate.
Inaccurate information leads to an unrealistic assessment of your profitability. Your accountant should also use the latest standards in the preparation of these documents. Hiring accountant to keep daily records is a good way of reducing the workload that comes with such assessments. Additionally, using the latest accounting software is an excellent idea because it eases this process.