Any bookkeeping, business or tax article contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor can it be used to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

Profits vs. Profitability: Why You Need to Track Profit Margins

October 22, 2018

As a business owner, there are two things that you should already know: increase revenues or reduce costs. Smart business owners can do both implementing marketing strategies and cost-cutting measure to achieve increased revenue and reduce costs. But, there are so many business owners that believe that you must increase sales and revenue to make more money and forget about the importance of trimming the fat and end up actually reducing the profits.

Here are some important key points so you can see the difference between profit and profitability:

Profits Alone Can Be Deceiving

People who know basic business on how to calculate profits. You add up total revenues less the total costs, and whatever’s left is your profit. But this is not as simple as that. For example, Company A spends $800,000 to sell $1 million in products and services, generating $200,000 in profits. Company B spends $300,000 to generate $500,000. The two companies generate the same profit ($200,000), but are they equally profitable?

The answer is NO. The more a company spends to reach the specific profit, the more vulnerable it is to minor cost shifts, which might put your business out. Let’s say Company A above spends $300,000 in health insurance costs, and those costs increase by 10 percent. That increases insurance costs by $30,000, reducing profits to $170,000. Company B spends $100,000 in health insurance costs. The 10 percent increase cuts into the bottom line by just 10,000, and profits drop to $190,000. Company B is now making $20,000 more in profit than Company A.

Profit Margins Provide a More Realistic Perspective

It’s important for businesses to track not only profit but also profit margin. Profit margin is the percentage of revenues that is actually profit. Seltzer says, “Sales are great, but if your margins are not good and your costs are too high relative to your revenues, then you have problems.”

How to Increase Profit Margin

There are basically two ways to increase a company’s profit margin. First, you can increase the price you charge for your products and services, but you must be careful and have an analysis of the impact of those increased prices on consumer behavior and total sales. The second is to know the behavior of your expenses, the safer approach is to control costs.

The Importance of Cutting Costs

There is a big difference between decreasing your cost and increasing your sales to be profitable. A minor decrease in cost will improve your profit margin more than a comparable increase in total sales. Look at every aspect of your business on how you can control your cost.

If you need help on how you can increase your profit, as well as help in getting powerful financial insights, help in achieving diligent tax compliance, and help in achieving a healthy cash flow, contact us today at admin@fas-accountingsolutions.com or 713-855-8035.