Profit and profitability refer to your businesses ability to make money. But while profit refers to the amount of money your business makes, profitability is more about the sustainability and financial health of your business.
Profit is the difference between what your business earns and what it spends. Simply put, if your revenue is higher than your expenses, you’re making a profit. However, to truly understand your business's financial health, you need to understand your business's potential for profitability.
How to Measure Profit
Measuring profit in your business involves calculating how much money your business keeps after covering its costs. Tracking profit helps you:
Know if your business is financially healthy
Identify where you're overspending
Set realistic goals for growth
Make informed decisions about pricing, staffing, and investment
Profit is most commonly measured using gross and net profit margins, also known as profitability ratios.
Your Gross Profit Margin (GPM) shows you how much you make from selling your product or services before you pay other business expenses.
Gross Profit = Revenue – Cost of Goods Sold (COGS)
GPM is the revenue remaining after paying COGS, which are generally expenses like rent, marketing, internet etc. Costs that were directly involved in producing the goods or service. The amount left over is called Net Profit.
Net Profit (NP) is your “bottom line.” If this number is positive, your business is making a profit after all costs are accounted for. This is the percentage of sales that remain after you have paid your business expenses. Businesses will sometimes quote net profit before tax.
Tracking these figures over time is crucial because a profitable month doesn’t guarantee long-term success.
What is Profitiablity?
While often used interchangeably, profitability and profit are not the same thing. Whereas profit refers to the amount of money a business makes, profitability is how you determine whether your business is successful, in a good financial position, and on track for growth. The profitability of a business is determined by several factors: expenses, demand, and competition.
Business Expenses
Business expenses are the day-to-day costs you incur for running your business. This includes home business expenses, operating costs like internet, phone, advertising, rent, and wages, and capital and inventory costs like computers, machinery, and tools. Expenses can eat away at your business’s profit margin and reduce the amount of income you make. In general, the more expenses a business has, the lower its profit will be.
Tip: Identify areas of your business where there may be excess waste. For example, a retail business that consistently orders too much stock, and as a result has it sitting in storage for months. To address this, the retail business could use past data and seasonality trends to predict the stock they’ll actually need to avoid overordering. This helps free up cash that could be used elsewhere and would reduce the cost spent on storage or product spoilage, ultimately, contributing to a business’s profitiablity because unsold items aren’t generating any revenue.
Take note of your expenses each month, so that you locate where costs can be cut. Regularly reviewing your spending helps you make informed decisions and improve overall profitability.
Market Demand
The profitability of a business is often determined by the demand for a product in the market. By knowing what your customers want, and producing the products or services they need then your company will sell more and your revenue will exceed your expenses.
Tip: Look after your existing customers, because it is more cost-effective to retain existing customers than to acquire new ones. Happy and loyal customers are more likely to return for future purchases and repeat business, and are likely to recommend you to their friends. One way to do this is through regular customer feedback, to ensure you understand their pain points, ensure it aligns with what you’re offering, and allows you to adjust to your customer needs to stay ahead of trends.
The market and customer preferences can change over time. By regularly reviewing customer data and adjusting your product or service accordingly you can continue to stay relevant and meet their evolving needs.
Industry Competitors
Staying ahead of industry rivals, diversifying, and introducing new product lines can help drive profit growth and ensure long-term profitability. Businesses within the same industry that offer similar products and services can erode each other’s profits.
Tip: To stay ahead of your competitors, businesses need to understand their customers and deliver greater value than your competition. For example, a local café notices that a nearby competitor is offering similar menus and prices. To differentiate themselves from their competitors, they choose to launch a loyalty programme, offer free wifi, or a seasonal menu.
By focusing on customer experience and value-added services, businesses can gain a competitive edge and stay ahead in the local market.
Reports Every Business Owner Should Review Regularly
To stay on top of your business’s profitability, here are five essential reports to understand:
Profit & Loss Statement (P&L): Also called an Income Statement, this shows your revenue, expenses, and net profit over a set period. It’s the go-to report to see whether your business is making or losing money.
Balance Sheet: A snapshot of your financial position, showing what you own (assets), what you owe (liabilities), and what’s left over (equity). It helps you understand your business’s overall financial stability.
Cash Flow Statement: This report shows how money moves in and out of your business, and whether you have enough to cover your obligations.
Accounts Receivable Report: This shows which customers owe you money and how long they’ve owed it. Unpaid invoices can hurt your cash flow.
Budget vs. Actual Report: This compares what you planned to spend or earn with what actually happened. It helps you stay accountable and adjust if things are off track.
Profitability isn't something you can guess, it’s something you measure. With the right reports and regular financial check-ins, you can spot problems early and make smarter decisions that grow your business.
Too small for a full-time accountant? Struggling to keep on top of your bookwork? Want to know how your business is performing regularly? Get in contact with me to discuss your tax and bookkeeping needs.
