Is your business efficient at generating profits? Is performance improving or getting worse? How can you tell? Profitability analysis.
While the C-suite might focus on net profit margins, as finance professionals, we understand that profitability analysis is more than a barometer of an organization's performance.
What Is Profitability Analysis?
Profitability analysis is a component of revenue planning. It enables you to evaluate the profitability of specific projects.
Profitability analysis influences decision making and drives future profits when done correctly.
How can you be sure that your profitability analysis processes are efficient and accurate?
Inefficient data processes cost U.S.-based businesses billions each year, and poor data quality costs companies $3.1 trillion each year. Improve your organization's profitability analysis and data collection processes so your company doesn't become a statistic.
- Not all revenue is created equal. Focusing on revenue growth alone only gives you a bird's-eye view of your company's financials, restricting insights into the overall competitive landscape.
- Create maximum value by gaining insights into where profits are won and lost by harvesting the power of data by using a central repository for all your company records and datasets.
- Benchmark your organization's current standing by comparing margin ratios, such as net sales, net incomes, revenue, operating income, taxes and other additional expenses.
- While sales teams want to celebrate every closed sale, only finance professionals know the true value of every deal using profitability analysis.
- Over 25% of business leaders state that insufficient technology makes embracing these advancements risky, while 39% recognize the need to embrace automation.
How To Perform A Profitability Analysis: 5 Key Methods
Profit can be analyzed in multiple ways, and it's an important KPI for finance teams.
The most common is through financial ratios called profitability ratios. The key profitability ratios are as follows:
1. Calculate Gross Profit Margin
As the name implies gross profit margin calculates revenue that exceeds expenses.
The formula for the gross profit margin ratio is (Net revenue - Cost of Goods Sold)/ Net Revenue x 100%.
2. Understand Operating Profit Margin
Operating profit margin is an important formula that measures revenue after operating expenses have been accounted for.
The formula for operating profit margin is Net Sales - (Cost Of Goods Sold + Selling, General and Administrative Expenses) / Net Sales.
3. Work Out Net Profit Margin
Net profit margin is calculated by dividing Net Income by Net Sales.
Net profit margin measures the amount of net income or profit is remaining after accounting for net sales.
4. Identify Return On Assets (ROA)
ROA measures your company’s efficiency in terms of generating earrings from assets. The formula is:
Net Income / Average Total Assets
5. Identify Return On Equity (ROE)
ROE demonstrates how well companies can handle shareholder contributions by measuring profitability in relation to stockholder equity.
The formula for ROE is Annual Net Income / Shareholders Equity.
Tips on Improving Your Profitability Analysis Processes
Most organizations will often only focus on revenue growth when developing sales objectives (setting quotas or measuring performance, for example). However, not all revenue is created equal.
When competitive landscapes shift, consumer demands change. As your organization seizes new opportunities, using profitability analysis (a metric of financial reporting) could help decipher specific results and deliver insights to the C-suite.
Instead of depending on a bird's-eye view, or worse yet, a gut intuition, of the company's financials, C-suite executives and managers can get fact-based answers about the profitability of each specific buyer, customer group, product, market and service line.
1. Harness the Power of Data
FP&A forums are teeming with finance professionals complaining about how time-intensive profitability analysis is and how challenging it is to compile accurate data. If you attempt to perform data-rich calculations with Excel spreadsheets alone, you won't be able to process your profitability analysis accurately.
You first need a foundation for data for your sophisticated operations. That requires exchanging manual data entry processes and the time associated with these tasks for a comprehensive digital solution to create a single source of truth (SSOT).
According to PwC's Finance Effectiveness Benchmarking Study, when you harness the power of technology-based central repositories to collect and store data, finance professionals can spend 20% more time on analysis and less time gathering and validating data.
Bottom line, if you are not using a comprehensive, yet simple-to-use financial analytics tool to track metrics to improve profit margins, setting that system in place is step one.
2. Benchmark Current Standings
Healthy profit margins depend on various internal and external factors. Benchmarking current profits allows you to ensure performance is consistently improving proactively by capturing profitability ratios.
Internally, you will need to compare segments and profit margins to past periods within the company. Externally, you can assess average margins and ratios in your industry. Elements of an organization's profit margin ratio include:
- Net Profits
- Net Income
- Cost of Goods Sold (COGS)
- Operating Income
- Operating Expenses
- Additional Expenses (i.e. repair costs, loan repayments, etc.)
Obtaining accurate benchmarks shouldn't require days of digging, either. s A benchmarking tool that uses CapEx software allows you to target key insights from specific datasets for improved analysis.
3. Know the Cost of Each "Win"
Not every newly closed deal is a win to celebrate. Known as customer profitability analysis, finance professionals can evaluate the true value of a new customer and how profitable each "win" actually is to the organization.
Assess marketing strategies, cross-channel engagement, time spent on closing and the entire customer journey to gain these insights.
However, you cannot gain these insights by studying expense and income statements or attempting to apportion operating and other fixed costs. It takes profitability analysis and the willingness to dig deeper to see how changes can strategically drive cumulative profits.
4. Establish a Schedule for Performing Profitability Analysis
How often your team performs profitability analysis depends on several factors, including industry type, the scope of the report and the period of the assessment. Most organizations conduct annual analyses.
However, while challenging, some metrics require more frequent review. A profitability analysis tool will help streamline this process to simplify the assessment process.
Challenges With Adopting Efficient Profitability Analysis Processes
We spoke to 175 finance professionals, operations specialists, and business executives from organizations around the world to discover the biggest challenges finance professionals face. We published the findings in our benchmark survey.
While 39% recognized the need for companies to embrace automation, 33% argued disconnected data and over 25% stated that insufficient technology makes embracing these advancements risky.
Furthermore, integration might create issues with the company's IT infrastructure, causing the IT department to delay adoption. As a result, some finance and operating teams continue to fall behind in long-range planning and forecasting, and 15% have no strategy whatsoever.
Accurate Profitability Analysis Requires Metrics You Can Trust
From the beginning, one primary purpose an organization strives for is to make profits. It's arguably the most critical factor in successful commerce.
Understanding profitability requires an innovative finance reporting tool that harnesses the power of Excel, taking data from on-premise data centers and cloud-based servers and securely storing it in one central repository. Get all the data you need from one place for more accurate reporting. Connect finance with sales more effectively by applying financial metrics to support a more strategic sales planning process.