Ways to measure profit
How do you measure profit? Here's a little secret about profit: it's hard to measure and there isn't a one-size fits all metric. Depending on who you speak to, their measurement of profit will be influenced by their past experience. As the owner of your business, it's critical that you know all the different ways profit can be measured, and then decide which ways are best for your company. Here are just a few ways to get started:
P&L Statement: Also known as the Income Statement. This financial statement will show you profit in a moment of time, but it won't show you the full picture. You'll also need to compare this statement to itself over time and look for trends.
2. Gross Profit Margin: This is an easy ratio to apply to your Income Statement. This ratio shows you how much profit you've made after paying your COGS (cost of goods sold). For service based companies, this number will be much higher than product based companies. If you are a service based company, you'll want to also check out your Net Profit Margin. Whatever it is you sell, compare this number to other companies in your industry to get an idea of where you stand. Also be aware that minor adjustments to the COGS or revenue can have a ripple effect in your gross profit margin.
To calculate GPM, subtract COGS from your Revenue and then divide by Revenue. Only you, the business owner, can determine what this percentage number "should" be.
3. ROIC (Return on Invested Capital): This is a calculation that won't be readily available on any of your financial statements. However, as the owner, you should know what this number is. Many entrepreneurs go into business with the idea that they'll be getting a higher yield on their initial investments than they would if they invested in the stock market, for example. So what is your return on the amount of money that you've put into your business?
You can also look at your shareholder's equity number on your Balance Sheet. This number will be made up of common shares of the company, preferred shares and retained earnings (what is also called "sweat equity" - when business owners "reinvest back into their company" by not paying themselves). Don't get me started on my soap box about sweat equity! However, keep in mind that the Shareholder's Equity probably does not reflect what is actually in the bank account.
4. EBITDA vs. Revenue: Some people say that revenue is a vanity number, and I agree. Owners tend to be very comfortable telling other people what their revenue numbers are (if the numbers are good, of course). However, I've met owners who make $5MM or $10MM in revenue, but still don't pay themselves a fair wage, or are losing money faster than they can make it. High revenue numbers doesn't mean you own a profitable company. However, it is a very important number. Perhaps a better indicator of profit for you to consider is what's called EBITDA ("ee-bit-dah"), which stands for "Earnings Before Interest, Taxes, Depreciation, and Amortization". Basically this number will tell you what your profit is after non-operating expenses. Your EBITDA is a magical number, and one that you should be intimately familiar with because it's a more accurate reflection of your profitability.
Remember that profit is a metric that builds VALUE into your business. Every business is different, so find out what similar companies are doing to measure profit. Then find a system that works for you. If you need help coming up with a profit system for your business, contact me to get started. Email hello@audaxwealth.com to schedule an appointment.
