Calculating Your Profitability
Let’s go out on a limb and assume that you don’t sell trilobites out of your garage—but your business still has revenue, expenses, and other factors to consider. And there is a collection of formulas, known as key performance indicators (KPIs), that can help you keep tabs on your profitability and find areas for improvement.
“Big businesses have been using KPIs to measure their success for years,” says business expert Tim Clairmont. “Yet many small businesses ignore this less-understood acronym…A manager can see if an employee is improving and if they are outperforming other employees by looking at their KPIs and tracking their results. But if you are self-employed or running your own firm, who is there to tell you what your KPIs are? Are you letting your business run you, or are you running your business? Moving from salesperson to businessperson or moving from a small business to a larger business requires a change in perspective. And one great place to start is to figure out your KPIs.”
Here are some of the KPIs that most small businesses use to gauge their performance and refine their profitability.
This is the formula used in our earlier business example. We took the revenue from the fossil sale and then subtracted the related expenses. What remains is the net profit.
Here’s the formula:
Revenue – Expenses = Net Profit
Given the simplicity of the formula, net profit is a popular way to get a quick snapshot of your business’s money-making efficiency. When your net profit is a positive number, you know you’re doing something right. When it’s negative, you need to evaluate your operations and seek improvements.
Net Profit Margin
This formula helps you to better understand the interplay between your revenue and expenses. The resulting ratio reveals the percentage of profit your company is generating from the total revenue you’re bringing in.
Here’s the formula:
(Net Profit ÷ Net Revenue) x 100 = Net Profit Margin
Gross Profit Margin
Next up is gross profit margin, a formula that illuminates the effectiveness of your business’s pricing strategies and provides a wide view of your business operations.
Here’s the formula:
Gross Profit ÷ Total Revenue = Gross Profit Margin
“At its core, the gross profit margin measures a company’s manufacturing or production process efficiency,” says asset manager Joshua Kennon. “It tells managers, investors, and other stakeholders the percentage of sales revenue remaining after subtracting the company’s cost of goods sold. Any money left over goes to pay selling, general, and administrative expenses. These expenses include salaries, research and development, and marketing, and they appear further down the income statement. All else equal, the higher the gross profit margin, the better.”
It’s always great to have a high profit margin, but the details of that percentage are relative to your industry. Traditionally high-margin industries include legal services and accounting. On the other end of the spectrum, successful hotels and car dealerships often operate with much lower margins.
Operating Profit Margin Ratio
Here’s 1 final KPI we’ll look at for this list—though there are plenty of others to consider. In a perfect world, your operating profit margin ratio would always be increasing. More realistically, there will be some occasional dips. It can be a cause for concern if the fluctuations become more consistent and pronounced, as that indicates poor management or major inefficiencies.
The formula is:
(Operating Income ÷ Net Sales) × 100 = Operating Profit Margin Ratio
As with the other KPIs on this list, your operating profit margin ratio can be an excellent tool for comparing yourself with the competition within your industry. As long as you know the industry averages and have data on your competitors, you’ll be able to conduct regular checkups on your business.
Putting Your Data to Work
Armed with the insights you gain from your KPIs, you’ll be able to target new ways to improve your efficiency and grow your business. Your goals always need to be measurable and actionable, and these formulas provide the fuel to help make them so.
“In my decade as CEO of a digital marketing agency, I’ve never met a company yet that succeeded in creating a refined digital marketing campaign without first coming up with equally effective key performance indicators for the strategies,” says marketing expert Oganes Barsegyan. “I’m absolutely convinced that the key to choosing KPIs is to contextualize them with your business. You must match them not only to your goals but also to a host of other factors, such as your strengths and weaknesses and the life stage of your business.”
So how do you intend to grow your business? Focus on actions you can take now that will yield results within the next 6–12 months. Maybe your growth plan involves opening new business locations and hiring new employees. Or you might choose to expand your product line. In some situations, the action might be as simple as purchasing a crucial piece of equipment.
There’s a substantial amount of due diligence required before you can take the first steps toward any of these goals. We’ve talked a lot about using formulas to see where your business currently stands and how it’s performed in the past, but the future plays a major role in your growth ambitions.
“Before you even start growing your business, you need to do some research,” explains Forbes. “You need to know what your business is capable of doing with its money and other resources available. Assess your business. Look at all the analytics, stats, and accounting records that are available to you. Analyze how your business has done in the past. And when possible, make projections of how you think your business will do in the future, such as sales projections.”
Each piece of information you collect gets you closer to achieving your business goals. They’re like rungs of a ladder, and without them, it’s nearly impossible to move upward.
Merging Data With Your Plan
Building upon this same ladder metaphor, the rungs of the ladder need to be attached to vertical poles in order to bring structure. That’s where your plan comes into play, as it provides the structure needed for your data.
Your growth plan should provide simple answers to the following questions:
- Why am I growing my business?
- How will I make it happen?
- What’s my timeline?
- How much money will it take?
- Where will I get these funds?
Your plans are a natural evolution for your business. Some are evergreen. Most help you reach objectives in a shorter period of time, then make way for subsequent plans to reach the next level of goals.
“We often make the mistake of thinking of a business plan as a single document that you just put together when you’re first starting out and then set aside,” says The Balance Small Business. “Something to check off the to-do list and be done with. But in actuality, the business plan for any business will change over time as the business develops, and any particular business may have multiple business plans as its objectives change. In the growth phase, an updated business plan is useful for forecasting or raising additional capital for expansion.”
Indeed, your plan does more than guide your growth. It’s also a required element for seeking financing. Without a written plan, lenders will probably view you as a business owner full of ideas but lacking direction.
Financing Your Growth
How will you fund your objectives? Planning is cheap, but the costs of executing can really add up. The good news is that there’s a wide range of options available to small business owners. Your ideal match will depend on factors such as your business purpose, business history, and financial health.
Here are 5 of the most popular financing products for business in growth mode:
SBA loans are served up by the Small Business Administration (SBA), a federal agency committed to helping disadvantaged business owners get the resources they need. The dollar amounts start around $50,000 and max out at $5,000,000. The interest rates and terms are usually quite favorable.
The process of getting an SBA loan involves massive amounts of paperwork, so they’re definitely not for the faint of heart. And the funds don’t arrive in your account for up to 3 months.
But if you have a flexible timeline and know that SBA loans are your best route, you should definitely apply. The most common types of SBA financing are SBA 7(a) Loans, SBA 504 Loans, and SBA Express Loans.
Taking your business to the next level often requires you to upgrade your equipment. With equipment financing, you can get up to $5,000,000 to fuel your business’s growth.
The money from this type of financing can be used for all manner of equipment needs. For example, you aren’t just limited to things like refrigerated trucks and dining tables and excavators. You can also spend it on office software, alarm systems, or even a fish tank for your waiting room.
Equipment financing can move fast, with the money often becoming available within 24 hours of approval. Even more importantly, the rates can start as low as 7.5%.
Business Lines of Credit
When you’re looking for convenience, a business line of credit is a great choice. It functions much like a credit card and gives you access to revolving credit. Amounts can start at just $1,000 and reach as high as $500,000.
It’s usually not too hard to apply for a business line of credit. If you’ve been in business for more than 5 months, bring in more than $49,000 a year, and have a credit score above 560, you’re a prime candidate.
The interest rates for a business line of credit can range from favorable to painful. So if you choose to go with this option, shop around until you find a rate that aligns with your growth goals. Plan on rates starting around 8% and possibly reaching up to 24%.
Business growth plans usually involve a variety of expenses, so term loans are one of the most popular types of financing available to small business owners. The funds from these loans can be spent on everything from boosting inventory to hiring staff to opening a new location.
If your needs are small, you can seek term loans as small as $5,000. When the demands are greater, you might want to seek funding closer to the maximum of $2,000,000. Even these larger loans can fund quickly, with the money usually hitting your account in just a few days.
Term loans can have favorable terms, and the rates begin in the neighborhood of 6%. So be sure to check out these loans as a possible solution to your growth requirements.
Short Term Loans
If your plans require rapid funding, consider these expedited loans. They have many of the same characteristics as a term loan, but a short term loan can deliver money to your account in as little as 24 hours.
The interest rates tend to be higher on a short term loan, starting at 8% and potentially going substantially higher. But if you find yourself in a situation where speed is of the essence, the tradeoff might be worth it.
There’s No Time Like the Present
If you have dreams of expanding your business, now is the time to take action. As long as you do your due diligence and stay on top of your financial details, you’ll have all the resources needed to make the kind of bold decisions that yield big rewards.
Every business is different, and each plan has its unique elements—but we’re all striving for the same dreams. Armed with data from your KPIs, you’ll be on the fast track to getting there.