If you’re wondering how to increase the profitability of your company; this article will provide you with plenty of information and tips. We’ll explain everything you need to know about sales and company profitability, how to determine and forecast it, and what you can actively do to make your company even more profitable.
Increase sales profitability for greater business success
By increasing your return on sales, you help your company achieve greater success and compete more effectively with the competition. Knowing your company’s profitability allows you to draw important conclusions that can be used for corporate management and support decision-making.
Corporate management
Profitability metrics enable you to effectively manage your company. These figures also represent externally how well your company is doing and how efficiently it operates. These are important indicators for shareholders and lenders to assess your company’s performance.
Corporate management
The key performance indicators for corporate profitability reflect on you as the manager and show your business partners how successful you are in managing your company. For example, if you have an increasing return on sales, this shows that you, as the manager, have taken measures to increase productivity in your company.
Decision-making
When strategic decisions need to be made, profitability metrics are also a useful tool. When it comes to profitability forecasting (which we’ll discuss in more detail later), knowing where you stand now and what your goals are for the coming years will make it easier for you to make decisions.
What key performance indicators are there for corporate profitability?
The profitability of a company or business can be viewed from various perspectives. The resulting key figures provide you with insights into various financial areas of your business and show you where untapped potential still lies. Below, we’ll show you some key figures for calculating your company’s profitability.
Return on equity
The return on equity indicates the interest rate at which you have “invested” your equity and thus generated your company profit:
Return on equity = profit / equity
The profit figure represents the net income after taxes from your annual income statement. The equity figure is derived from the assets side of your balance sheet.
Return on equity fluctuates from year to year, as both your profit and your invested capital are subject to annual fluctuations. For example, For example, if you invested $500,000 in equity over a fiscal year and generated a profit of $75,000, your return on equity for that period would be 15%. This metric directly evaluates your company’s profitability.
This metric directly assesses your company’s profitability.
Return on debt
The return on debt indicates the interest rate on your borrowed capital, i.e. the amount of interest costs:
Return on debt = interest Expense / Average Total Debt
If you borrowed capital in the form of a loan, you must repay it with interest. For example, you took out a loan of $100,000, for which $20,000 in interest accrued within a fiscal year. This results in a return on debt of 20%.
It should therefore be in your company’s interest to keep this value as low as possible, as interest represents a cost factor for you.
Return on total capital
The return on total capital measures profitability. It does so by comparing both equity and debt with profit and interest on debt.
Return on total capital = (profit + interest on borrowed capital)/total capital
Companies are most interested in this metric because it measures how profitably the capital employed is working within the company. A higher return on total capital employed means capital is working more efficiently. Increasing profit while simultaneously reducing capital will most effectively increase your company’s profitability.
Return on sales
To calculate return on sales, divide profit by sales.
Return on sales = profit / sales
Profit refers to the annual earnings after taxes. You can find sales figures on your income statement. It is shown there as sales revenue and corresponds to the total sales generated by the company in the respective fiscal year. For instance, if your profit is $50,000 and your sales are $500,000, your return on sales would be 10%.
This metric only becomes truly interesting when you calculate it for several fiscal years and then compare the results. If your return on sales has increased continuously over the past few years, that’s a good sign, as it indicates that productivity in your company has increased (assuming you haven’t artificially counteracted this with price increases).
Conversely, when the return on sales is declining, the reason is often declining productivity. Therefore, you can use return on sales to measure your company’s efficiency.
When is a company/business considered profitable?
That’s probably the crucial question this article revolves around. Calculating the above metrics is one thing, interpreting them is another.
In general, a company is profitable when it can cover its costs with its revenue and still generate a profit. Depending on the ambitions of the managing director, there are different answers to the question: “When is a company profitable?”
Therefore, a blanket statement or specific values regarding profitability indicators cannot be derived. However, some principles can be derived from the various indicators:
- A high return on equity signals that a company is performing well financially.
- The lower the return on debt, the better for the company because there are fewer interest costs.
- An upward trend in return on sales year over year suggests improved operational efficiency.
- A high return on total capital indicates financial success. It also shows efficient use of available capital.
What can managers do to increase profitability?
Managers now have a whole host of adjustments they can make to improve the profitability of their company.
However, good intentions alone and the statement “I want to become more profitable” are not enough to sustainably improve a company’s profitability. Therefore, the task of those responsible is to set concrete goals in the form of defined key performance indicators: What profitability should be aimed for in the short, medium, and long term? Only in this way can strategies be defined and concrete measures implemented that will lead to increased company profitability.
What is profitability planning and what are its objectives?
As part of profitability planning, managers create a “roadmap” outlining the company’s future direction in the coming months and years, as well as its profitability. Demand levels and supply planning are analyzed. Profitability planning is about determining whether the company’s expenditures (costs) are worthwhile when compared to the expected profit. A profit forecast is created that compares the expected costs and profits.
Profitability planning also allows you to estimate the success of an investment. It’s also important for submission to a bank when applying for a loan. Advisors want to know whether the business model or company is viable. To assess this, concrete figures are necessary.
What components does profitability planning have?
Profitability planning incorporates both sales and operating cost planning. These two are usually prepared for one year, while profitability planning typically covers three fiscal years.
Sales plan
This includes a forecast of expected sales. If your company has been operating for some time, you’ll already have some figures from previous fiscal years to serve as a guide. The more accurate the forecast can be, the better.
Operating cost plan
This is where all of the company’s ongoing costs are listed: salaries, rent, travel, marketing and other operating costs incurred during a year.
How do you create a profitability forecast?
Now it is a matter of combining the sales and operating cost plans into a profitability forecast.
The expected costs for goods and materials are deducted from the sales forecast to obtain the so-called gross profit (expected profit) for the planning period.
Operating result (before interest and taxes) is the difference between gross profit and operating costs. If taxes and interest are also deducted, the annual profit (if the result is positive) or the annual loss (if the result is negative) is obtained. This calculation is carried out for three fiscal years and then the key figures for the expected company profitability for the next three fiscal years are calculated.
Valuable information can be gained from such forecasts, especially when they fall short of expectations. In such cases, managers should consider how to improve corporate profitability to achieve profitability targets.
How can you increase company profitability?
There are numerous measures to improve corporate profitability. These can be divided into three areas: increasing revenue, reducing expenses, and increasing efficiency.
Increase revenue
Price increases
Especially if you have many long-standing customers, they can often be persuaded to increase their prices because they know they’re getting good quality from you. In this case, raising your prices is often acceptable.
However, proceed moderately. A price increase can be gradual over months or years. Also, keep an eye on what your competitors are doing so you can keep your prices within budget.
If your machines are running at full capacity, you can no longer increase capacity, and you still aren’t gaining new customers, or demand for your products is even declining, then you have reached your maximum potential in your core business.
If you want to further increase your profitability, you need to explore new horizons. Take a look at what your company excels at and which markets or industries you might be able to position yourself in with a new product.
Review your product or service range
Selling a product in small quantities but with high sales is suboptimal for profitability because you’re dependent on one or very few customers. If demand suddenly drops, selling the product is no longer worthwhile. Therefore, check whether a product or service you offer not only generates sales but also profit. Only then can you speak of profitability.
Cost reduction
Renegotiate contracts
Sometimes it can be worthwhile to renegotiate contracts with existing suppliers to get better terms. Look around at other suppliers and get quotes from them. You have a good chance if you have high order margins. If this isn’t the case, look directly at the wholesaler.
Reduce operating costs
Leaving the lights on in the basement all day is not only wasted energy, but also wasted money. You may not have thought about such trivial things, but the consumption of electricity, water, and energy for heating represents a significant cost factor for many businesses, and one that can be reduced through very simple measures.
Instead of visiting the customer directly on-site, you can invest in a video conferencing system once and save on travel costs in the future.
Increase efficiency
Check and optimize inventory
Warehouses can also represent a significant cost for a company, as they require space and personnel. More efficient warehousing can therefore contribute to higher profitability. This requires good planning and inventory management. Appropriate software can help you keep track of everything.
Automate processes
A frequently underestimated aspect of day-to-day operations is process automation. Many tasks are still performed manually by employees, such as typing account balances into Excel spreadsheets, although tools now exist to take care of this task. Routine tasks that must be performed daily should be examined to see whether they can be replaced by automated alternatives.
Conclusion: Increase profitability through efficient liquidity management
A key metric for assessing your financial situation is your liquidity, or cash flow. By keeping an eye on your incoming and outgoing cash flows at all times, you can keep an eye on costs and take early countermeasures if financial bottlenecks are expected. In the long term, effective liquidity management contributes to increasing your company’s profitability.
Liquidity management software also supports you in creating your profitability forecast. The software automatically connects to your bank accounts, allowing you to always keep an eye on current transactions and account balances and use them for cost and revenue planning.
The software saves you and your employees from tedious manual work on Excel spreadsheets, where account balances and transactions have to be entered individually. With efficient liquidity management, you can increase your company’s profitability – long-term and sustainably.