Knowing how our company's profitability works is very important to understand which resources we're using correctly and which ones are being wasted. We need to optimize the time we devote to each task to increase our profitability.
In this article, we'll tell you everything you need to know about profitability, how to measure it, how it's related to the other areas of your company, and what you can do to improve it.
Profitability is one of the most important financial indicators for a company since it allows you to know the profit you get after you invested. We could say that it's the capacity that a company has to generate profits or revenues.
Profitability is very important to make comparisons between companies or investment projects since it allows you to know the risks and the capacity for generating a return on investment. Both types of profitability (economic and financial that will be described later) allow you to detect problems and think about strategies to generate profits or identify if you're wasting resources.
What types of profitability are there?
Economic profitability and financial profitability.
- Economic profitability refers to the profits that a company got for having made a particular investment. It's also usually described as the capacity that assets have to get revenue. As all assets are considered here, this type of profitability also includes loans. Economic profitability is usually expressed in percentages.
- Financial profitability is very similar to economic profitability but it refers to funds invested by the company. It's the profitability got after the investment was made.
ROI (Return on Investment) refers to investment efficiency. It's related to economic profitability.
ROE (Return on Equity) refers to the investment efficiency including tax expenses since it is considered a total amount. It's also related to economic profitability.
ROA (Return on Assets) is one of the most important indicators to measure financial profitability. It only takes into account the net assets of the company.
How can you measure each type of profitability?
Economic profitability can be measured by using some financial indicators to evaluate the effectiveness of business management. The most important financial indicators of this type of profitability are, on the one hand, the ROI (Return on Investment) that involves the profitability of the company's assets and its efficiency when used.
The equation is: gross profits / total assets.
The other indicator is the ROE (Return on Equity) that involves the net profit got compared to the stakeholders' investment.
It's calculated this way: net profits / equity.
This result shows the capacity of a company to invest the assets it has, both external and internal.
As its definition states, calculating the financial profitability is almost the same as the economic profitability but with the company's equity. One of the most important indicators for calculating it is the ROA or Return on Assets.
It can be calculated by the relationship between performance and total assets, and it's applied with the following equation: net profits / total assets.
It's expressed in percentages and an example would be: if we have a million dollars in an account and the interest made is one thousand, profitability is 10%. It's calculated by dividing the amount earned by the amount you needed to earn it.
How can you know if a customer is profitable?
To know if a customer is profitable, first, we need to establish what a profitable customer is: for our company, profitable customers are those who have a larger income flow than our expenses; that's to say, a customer's profitability is based on the profit our company makes thanks to the service we provide to that customer. We also have to take into account mid or long-term profitability a customer can provide us with; as the commercial relationship grows, the profit per customer increases so loyal customers are very good for our company. Next, you'll see some tips to know whether a customer will be profitable or not:
- Make sure you know how you will receive the money in exchange for your services since getting it in cash does not involve the same cost for you as if you receive it monthly, for example.
- Get information about the economic situation of each new customer to avoid problems in the future.
- Get the right software for your company to collect all the information about your customers; it'll be a very useful tool to manage the profitability calculation of each of them.
How can you improve your company's profitability?
The most important suggestion we can make is not to rely on just one source of demand; however, we can also give you some useful tips:
- Set smart goals (SMART).
- Establish processes in the company.
- Take care of your customers.
- Monitor and check your expenses and costs.
- Maximize the margin of every product/service.
- Manage stock efficiently.
- Plan and manage.
- Encourage your employees and explain to them what they mean to the company.
- Invest in technology.
Keys to improving the profitability in the construction industry.
It's very important to keep in mind all the resources that are used in construction projects (human, technical, and material) to have an idea of the impact they can have on the economic results. These three resources should work together to achieve maximum efficiency and not lose the profitability of a project.
Many expenses in a project depend on the time you need to carry it out, so being organized is vital. An alternative you can take into account when we carry out a construction project is to buy the materials needed beforehand; this will ensure you'll have them when the other resources are available and you'll save money. Undoubtedly, technological tools and software help you a lot to automate processes and are other allies to achieve greater profitability in these projects.
Profitability in marketing agencies
In most marketing agencies, it's very difficult to know their real profitability since, many times, they don't see the total profits they made after an important campaign in which they invested a lot of money to attract more customers.
The most common problems we find are:
- Not knowing the profits made in the last work carried out by the agency.
- Not knowing the production capacity of your agency.
- Not using data to calculate your budget.
- Lack of well-defined roles within the agency.
- Lack of financial profitability indicators.
- Manual processes that resist being automated.
It's also important to automate processes in marketing agencies. This helps improve the productivity of the teams and, if you have more productive resources, you're closer to getting the desired profitability.
As we have seen, profitability is an indicator we need to take into account in our business in any sector. To conclude this article, we'd like to emphasize that profit mustn't be confused with profitability. Profit is a simple calculation got by subtracting income and expenses; if the result is positive, it means that profits are higher than expenses. It's a basic concept but a useful indicator to know the short-term results we can get with simple investments. Profitability is a wider concept that allows us to see beyond immediate profits. It allows us to know the real return on investment and make comparisons between the profitability of another type of investment. This is why, today, profitability is the most used concept in most companies (big and small) and we believe that it's the most complete indicator we can apply.