To make strategic business decisions, you need to get into the specifics of your numbers. It’s not as simple as knowing you’re profitable. You must understand where you’re most profitable, so you know how to best run your business.
This isn’t a set-and-forget, once-per-year review. The profitability of your products and services is constantly changing. Depending on your industry, labour, material costs, marketing, operational expenses, inflation, and other variables influence profit margins. Customer demands and the competitive landscape also change overtime, and you need to know what to focus on (and what to drop).
Certain products and services will have higher profit margins, which will allow the freedom to continue selling those with a lower-margin – especially if this is the type of work you enjoy doing the most.
Your profit margins should be viewed in line with your business and life goals. Are you considering expanding your company interstate? Look at the popular products and which bring in the highest profit margin. Knowing your numbers grants clarity to all decisions, not just the financial. Take a ‘whole of life’ approach to put your numbers into context.
Your profitability is more than your overall revenue. You might be losing money, time, or opportunities without realising. No matter how big or small your operation is, you can’t strategically grow ignoring your profit margins.
Calculating your profitability
You’ve, most likely, got into business for freedom. Lifestyle freedom, financial freedom, time freedom. But somewhere along the way, the business takes over your lifestyle, finances, and time. To get back to an empowered state, review your profit margins regularly. There are two margins to consider: gross and net.
It’s a simple formula:
Gross profit = net sales – cost of goods
Net profit = gross profit – overhead expenses
Before you can run your products through these calculations, you need all your operational expenses, your total sales, and revenue per-product or service.
When working out your expenses, there will be fixed and variable overheads. Calculate the total fixed costs and use the average percentage across each product (or product category). The variable costs can also be used as an average or, if related to a product, added to that specific calculation. For example, rent is a fixed cost whereas shipping a specific order is variable.
Make a list of every product or service you sell. If it’s in the hundreds, you might need to calculate profit per product category.
Build in profit
To work out markup, a typical calculation is: (gross profit / cost of goods) x 100.
To ensure you’re breaking even and bringing in profit, use this formula for each product or service to understand how many units you need to sell before you start marking a profit: overhead expenses / (unit selling price – unit cost to produce).
You should always be able to know which are your top, most profitable products. Update your calculations each month and do quarterly and annual reviews. Look for patterns to use in your high-level strategic decision making.
This is how you build, run and grow a business that serves you and sets you up for a successful life.
Know your numbers, know your plan
Understanding where your business is most profitable is an important piece of information that informs your strategic decision making. However, it’s just one piece of the puzzle. Successful businesses require a holistic approach to their strategy, taking a ‘whole of life’ approach to consider all business and personal factors.
At Altitude, we have years of business strategic planning and advisory experience. We can support you to set and achieve all your goals in life, while growing a profitable business.
Get started today and book your free 15-minute clarity call with us.