How to Understand and Use a Profitability Analysis

What if your business was far less successful than you expected?

You won’t really know if your business is doing well until you conduct a profitability analysis. Unfortunately, many businesses don’t understand how to create and use such an analysis.

Want to take your business to the next level? Keep reading to learn how to understand and use a profitability analysis.

What Is a Profitability Analysis?

Our guide will help you conduct and understand a profitability analysis. But first, we need to answer a basic question: what is this kind of analysis?

This type of analysis is sometimes referred to as a profitability ratio analysis. That is because you cannot calculate profitability without taking several different factors into account. Keep in mind that profitability is very different from your cash flow.

It begins with determining different kinds of profitability. You’ll need to calculate your gross profit margin, net profit margin, and the return on both assets and equity.

This gives you the raw information you need to understand the general profitability of your business. And you can then use financial models such as the DuPont model to better understand the returns on assets and equity. And with this granular data assessment, you can then make changes to boost the overall profitability of your business.

As you can tell, things can get pretty complicated. But professional financial services can help you figure everything out!

Why Is Profitability Analysis So Important?

Now you know more about the basics of profitability analysis. But do you understand why that analysis is so important for your business?

On the most basic level, such analysis can verify that your business is making money. Considering the general failure rate of new businesses, it’s especially important to strive for profitability in those early years.

But simply generating a profit is not enough. With the right analysis, you can gain a very specific idea of how much profit you are generating and how well you are meeting (or failing to meet) your different KPIs.

Ultimately, you can’t sustain your business without collecting data via analytics. And profitability analysis helps you comb through your data and make sure that your business comes out on top.

Other Factors to Consider

On paper, profitability ratio analysis is fairly simple. You’re just completing a series of equations and determining what this means for your business finances. But there are still some other factors for you to consider.

For example, the presence of competition can decrease your profitability. And even if you are making a decent profit, an understanding of how well the competition is doing can help you understand if your business is measuring up.

The size of your business is another factor. Before expanding your business, you must first verify that there is enough demand for your product to justify doubling your production.

You also need to keep an eye on direct expenses. Unlike overhead, these expenses are going to increase as you increase production, and this might ultimately impact your bottom line.

What’s Next?

Profitability analysis is crucial to the success of your business. But it’s also difficult to fully calculate, and even a small miscalculation can hurt your bottom line.

But you can make sure everything is accurate with the help of Sterling Tax & Accounting. From bookkeeping to financial services to virtual CFOs, we have you covered. To see what we can do for your business, schedule an appointment today!