Businesses carry out various activities to generate revenue and the profit made by a business is what is left of the revenue once costs, expenses, and taxes are subtracted. Profits made by a business are usually reinvested in the business and the three main types of profit are gross profit, operating profit, and net profit.
While businesses aim at making profit through various business activities, they also evaluate the profitability of business performance. Although often used interchangeably, profit and profitability are two different accounting metrics.
Both profit and profitability are used by a trusted business advisor when analysing the success of a company. As explained above, profit refers to the total revenue minus expenses and it is an absolute number. Profitability is relative and is used to determine the scope of the profit a business makes in relation to the size of the business. If you are outsourcing your finance, statutory reporting services may provide analysis on the profitability of your business.
Profitability can be described as the ability of the business to produce a return on an investment based on its resources in comparison to an alternative investment and is a measurement of efficiency. However, a company is not profitable simply because it makes a profit.
When considering profit and profitability, a common profitability ratio used by financial management services and company secretarial services UK is a profit margin.
A profit margin is a percentage figure and indicates how much profit a business has generated for each sale or the percentage of sales that have turned into profits. Profit margins are extremely useful to businesses and a company may use outsourced financial management services to report on their profit margins on a quarterly or annual basis.
Tracking profit margin
Regulations may require a business to use financial reporting services to prepare and submit reports on profit margins on a regular basis but compliance is not the only reason a business should track profit margins. There are several reasons why profit margins are significant to a business and a trusted business advisor will explain to any business why it should track this indicator.
One of the main reasons a business should track profit margins is because they reflect the difference between the costs of production and product revenue. By analysing the profit margin, finance and accounting services you have chosen to outsource your finance to can consider the expenditure to cover running costs while also leaving profit for the business owner.
A business can also track profitability trends with the use of a profit margin. A reliable financial business advisor will encourage using profit margins to track profitability trends as opposed to the company’s gross profit.
The reason for this is that although gross profit may increase over time, there could be changes in revenue and fluctuations in fixed and variable costs. An accountant in Ilford that you have outsourced financial statement services to will thus tell you that the profit margin acts as a better indicator of profitability.
Over time, a business owner may want to make certain changes to the business. This could be by deciding to outsource finance and accounting services, for instance bookkeeping or company secretarial services. As a business owner, you may want to outsource your finance after weighing the pros and cons of doing so.
You may also want to make changes to product pricing, which affects profit and profitability. When consulting with a trusted business advisor or accountant on product pricing, you may consider your profit margins as well as demand, competition, and target audience. This is another reason to track your profit margins.
As important as it is to analyse your profitability and improve or adjust business activities to generate more income, it is vital that you track the performance of your competitors. Analysing industry standards and trends will help you improve your own business and one of the ratios used by businesses to compare each other’s performance is the profit margin.
Statutory reporting services and a financial management service may use this indicator to analyse the industry and your performance compared to competitors. This can help you make decisions on increasing product prices or lowering production costs.
It is also an indicator used in forecasting and planning and financial reporting services you may want to outsource your finance to will analyse your profit margins and help you plan the future of your business.