Everyone is familiar with the old saying that “you have to spend money to make money.” However, while the sentiment is well-understood, one crucial thing it’s missing is specificity. Precisely how much money should be spent on any one project or company? How much is too much?
In this article, we’ll break down a few of the different factors that should be taken into account when considering a business’s expenses versus its profitability. Keep in mind, this is a fairly brief overview of major concerns and points of focus and should not be taken as an in-depth analysis. However, it can be used as a launching point to conduct a thorough profitability analysis of your business in order to ensure that you’re currently operating — or at least moving toward operating — in the black.
Put Yourself in the Right Mindset
Before you put pen to paper, download a financial app, or open up a spreadsheet, it’s important to start by putting yourself in the right state of mind. In other words, if you want to properly assess your company’s profitability (or lack thereof), you must approach the issue with the right mindset. This includes:
- Setting and managing expectations: Don’t simply “shoot for the stars” and then regret when you don’t meet astronomical benchmarks. Consider reasonable goals that your company should be meeting and keep them in mind as you assess.
- Be a businessman, not just an entrepreneur: While that entrepreneurial vigor is always important, especially when starting a business, there’s a point where you need to shift from pure entrepreneur to a businessman mentality. This means maintaining that True Colours entrepreneurial spirit while simultaneously being willing to dig into nitty-gritty operational considerations (such as assessing profitability).
- Be patient and don’t panic: The truth is, you may not like what you find — and that’s okay. The important thing is that you stay calm and collected as you consider where your company needs to improve.
By starting in the right state of mind, you will be able to objectively judge where changes should be made.
Measuring Your Current Profitability
Once you’re in the right mindset, it’s time to measure your current profitability. This can be done through several different measurements and key performance indicators (KPIs). Here are a few of the primary ways to assess your current state of profitability:
- By calculating your break-even point: This is a good way to start. It compares how many sales you must make in order to cover your various expenses. This can serve as a baseline for what you must maintain in order to remain viable as a company.
- By calculating your profit margin ratios: Figure out your company’s gross profit margin ratio, operating profit margin ratio, and net profit margin ratio. These — especially your net profit margin ratio — can help you see how much profit you are getting out of your total sales.
- By calculating your return on assets (ROA) and your return on investments (ROI): These KPIs compare how much you’ve spent in assets and investments compared to how much you’ve received in return.
Identifying what KPIs are important and then calculating them is a great initial step in discovering how your expenses and profitability currently stand.
Review for Errors or Waste
It’s always a good idea to take the time to assess where you may be incurring unnecessary expenses, especially those you may not realize are withdrawing regularly. Minimizing or eliminating these can quickly increase your profit margin with minimal effort. For instance, areas of financial waste in business might include:
- Bad hiring practices.
- Expanding too quickly.
- Subpar forecasting.
- Poor debt management.
There are other ways that costs can get out of hand as well. For instance, the federal minimum wage is currently $7.25 an hour. However, there are legislative efforts to increase that number to $15 an hour. If that were to take place and a company neglected to respond by decreasing their workforce accordingly, they would quickly find themselves operating in the red.
Build a Competent Team and Lean on Technology
It’s no secret that all forms of tech, from the internet of things to cutting-edge AI, are already busily transforming the business world. Fortunately, many of these changes have made it easier for companies to cut down on operating costs. If you want to increase your profitability, it’s wise to lean on technology to do so.
For example, you can eliminate many arduous tasks, such as payroll or accounts payable duties through simple automation. This can both decrease workload and save time and resources spent on audits or taxes.
Along with adopting new tech into your company, it’s also important to build a competent team that embraces a continuous learning environment. While it may increase profitability, the constant changes in technology also naturally demand a team that can dynamically adjust to whatever changes come along. This way, you won’t spend extra time or money constantly training, re-training, or hiring new employees to keep up with the changes happening.
Adjust with the Future in Mind
To recap, begin your expenses-versus-profitability assessment by putting yourself in a healthy, constructive mindset. From there, calculate your current profitability, comb over your company for areas of waste, develop a competently flexible team, and lean on cutting-edge tech. These will help you simultaneously reduce costs and keep your company on the front lines of your industry.
If you can apply these principles on a regular basis, you can consistently catch errors and financially harmful behaviors before they turn into serious concerns. This, in turn, will help you maintain both viability and profitability over time, regardless of the shifts and changes that your company may face.