Profitability is an economic indicator with which you can find out the efficiency of resource use. And it doesn’t matter what kind of resources we are talking about. In large companies, using the profitability indicator, literally everything is analyzed.
You can find out how profitable it is to invest in a company or how much profit the purchase of raw materials at a specific price will bring. Can be considered based on human resources. In this article, we will tell you how to generally assess the effectiveness of a company and calculate the return on sales in business.
How profitability is calculated
Speaking about calculating the resource efficiency indicator, it is more correct to use the term “profitability ratio”. It is usually considered as the ratio of profit to the resources that are invested to create it. The coefficient can be a specific monetary value, or it can be measured as a percentage.
For example, we want to understand which company is performing better. You can count it like this.
The businessman is engaged in the production of pies. He sells pies worth 100,000 rubles a month, and spends 30,000 rubles on flour and other inventories. Profit – 70,000 rubles.
To calculate the profitability of the company’s inventory for this month, we divide the profit by the resource cost: 70,000 rubles. / 30,000 rubles. It turns out 2.3, or 230%.
Another company spends less money to produce a similar volume of products, for example, buys resources cheaper. It turns out that the proceeds of 100,000 rubles. she spends only 20,000 rubles and makes a profit of 80,000 rubles.
The profitability of her inventory is 4, or 400%.
It is more profitable to invest in a second company.
What is the profitability
The profitability can be calculated for anything – we just take the profit and divide it by the cost of any resource. For example, such indicators are usually used to evaluate a company.
- Return on Assets– Find out how well a company is using real estate, machinery, equipment, money and other assets.
- Profitability of fixed assets– consider the efficiency of using the resources that the business uses for production, but which are not consumed, but wear out. This includes premises and various machines, not raw materials.
- The profitability of current assetsis, on the contrary, the efficiency of using the resources expended. For example, raw materials or money.
- Return on investment– how profitably the company uses the raised money. This indicator is needed to calculate the return on investment.
There are other types of profitability – for example, they consider the efficiency of the project, equity capital, production.
Rate of return: what should be the efficiency
There is no universal indicator for any industry. This ratio is just an economic indicator that shows the ratio of profit to something. Excluding other factors and costs.
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If the profit margin turns out to be negative, the company is probably operating at a loss. In other cases, a market assessment should be carried out. In some industries, a 20% profitability is considered a huge success, in others, on the contrary, 20% will be too low a coefficient.
Formula for return on sales
Return on sales is usually highlighted as a separate indicator – with the help of it you can not only determine the effectiveness of investments, but understand the percentage of the profit share of all revenue.
Tracking the profitability of sales helps to avoid a situation where there is a lot of money in the business, but there is no sense in it, because all profits are eaten up by expenses.
The return on sales is usually calculated in two ways:
- profitability in terms of gross profit, that is, profit before taxes and loans;
- operating marginis the share of net profit in total revenue.
You can count like this:
Profitability = Profit / Revenue × 100%
Calculation examples
The company received 10 million rubles last year. revenue is all the money that came to the company’s accounts from customers. After deducting all production costs and salaries, 2 million rubles remained.
Gross profit margin: RUB 2 million / 10 million rubles. = 0.2, or 20%
Business seems to be doing well. But if you remove the loan payments and all taxes from the profit, it turns out that the company received 500,000 rubles. net profit.
Operating margin: RUB 0.5 million / 10 million rubles. = 0.05, or 5%
It is necessary to decide whether it is worth continuing to engage in a business that generates 5% of net profit for every ruble invested.
How to improve your ROI
Return on sales is the share of net income in the company’s total revenue. You can increase it as follows:
- Cut costs and keep the same revenue. This means that the profit will increase.
- Increase revenue without proportionate cost increases. For example, make sure that the sales manager closes not 10 deals per month, but 20.
- Reduce expenses after gross profit – that is, repay a loan or take a loan at a lower interest rate, optimize taxes.
When calculating sales efficiency, it is better to take not one, but several time periods. For example, calculate the coefficient for two or three quarters. This will help evaluate a business with a pronounced seasonal demand: in this case, the calculation of profitability in one quarter will show low efficiency, and in the next quarter, the ratio may grow several times.
Here are some working and specific ways to improve your ROI in any business.
Increase the price of the item. Usually, an increase in value even by 1–2% can improve the financial condition of a company, and such a small increase will not cause a negative reaction from regular customers. At the same time, you should not use price increases if the company’s competitive advantage is based on keeping the cost low.
Before raising the price, it is worthwhile to study the market and find out the cost of similar goods and services from competitors.
In the B2B segment, price increases are often presented as a marketing campaign and used to increase the company’s total revenue. For example, they send clients a letter, where they tell about the price increase in a month, and offer a condition: if the client pays now, for several months, then all advance payments will be considered at the old price. It turns out to be a profitable deal for everyone: customers save money, and the company receives money for several months of work in advance.
Reduce raw material prices. This is a classic way to keep costs down. For example, you can analyze the market and find out where the prices are lower, then contact your counterparties and ask for a discount. Or offer to save in some other way. Let’s say you will pay the same, but they will deliver the goods to the warehouse themselves. Finally, suppliers can be changed.
Reduce personnel costs. This does not mean that you need to immediately cut someone. Instead, analyze how employees contribute to the company. Perhaps someone has long outgrown the position, performs work very quickly and freelances in their free time – such people can be offered to switch to a deal.
Automate processes. For example, in the sales department, you can implement a CRM that will generate and send documents and messages to customers. This will save managers’ time, they will be able to deal more directly with sales.
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Increase your average check. This helps to reduce the costs of the sales process: the manager puts the same amount of effort, and the revenue is higher. The classic way to raise a check is to introduce so-called cross-selling , when a customer is offered related products.
Pass some of the costs to the buyer. For example, in an online store, the usual delivery scheme is by courier to the door of the apartment. You can offer the client a small discount for pickup, this will slightly reduce the cost of each transaction. If the business is focused on mass sales, pickup will help you save a lot.
An effective way to increase profitability in any industry of a company is to deal with the so-called excessive traffic, developed traffic. For example, when one conditional task “buy office furniture” provokes a lot of additional communications. Employees begin to find out: what kind of furniture, in what quantity, at what price, with whom it is necessary to agree on the allocation of the budget and the procurement project.
The setting of SMART tasks and the finished work of the employee as a philosophical principle of the company’s work will help to remove unnecessary movements .
