4 Metrics for Gauging Business Profitability
For many business owners, higher revenue is their objective, but higher revenue does not mean a better business. A high profit should always be the objective, and as a company leader, you’re likely willing to do whatever it takes to reach your profit goals.
But before you can get to that point, you have to know what areas, reports, and calculations are useful in driving your profit.
To help you out, we’ve provided a list of the four most relevant metrics you can refer back to when analyzing and improving your profit.
Before diving into the more nitty-gritty profitability metrics, you should conduct a break-even analysis. This will tell you the number of units, products, or services that need to be sold to meet the amount of money it costs to produce the unit, products, or services.
You can find your break-even point by dividing the fixed cost by the variable cost subtracted from the selling price.
In equation form, it would look something like:
(selling price – variable cost)/fixed cost
When you have this number, it will serve as a reference point for creating profitability and sales goals because you know this is the absolute minimum you need to sell to stay afloat, meaning all of your goals will be set somewhere above that number.
Gross margin is the lifeblood of your business. While certain expenses in your SG&A (selling general and administrative) may fluctuate from period to period, your gross margin should stay relatively consistent. If it doesn’t, this should be an area of focus.
For example, you may need to run an analysis to see if you are marking up your product/service enough, or maybe you are not planning your shift capacity appropriately and are paying too much overtime. There are plenty of reasons for your gross margin to dip, so make sure you are diligent in keeping a consistent number.
You can find your gross margin by taking your total revenue and subtracting it by the cost of goods sold, then dividing that number by total revenue.
Once you’ve calculated, this number will tell you how your production costs relate to your revenue. As mentioned before, it is a great indicator of where you can make adjustments to your business to yield higher profits.
Labor Cost Per FTE and Gross Margin per FTE
Labor is one of the largest expenses for many businesses, which is why it matters when looking at profitability. An FTE (full-time equivalent) measures the number of full-time employees or the number of employees that add up to a full-time employee, so finding the labor cost per FTE will show you exactly how much you pay for labor per hour (or other unit of time).
To calculate labor cost per FTE, find the total of all the labor expenses (in the past year, for this example), which can include:
- Benefits and insurance
Once you’ve found the total of your labor expenses, divide it by the number of employees you have. This gives you the cost per employee per year. Once you’ve done that, divide that number by the total hours worked throughout the year to get the cost per hour. Look at the rate of growth in this area compared to the rate of growth in your gross margin per FTE to make sure your growing profits are covering your growing labor costs.
As a refresher, EBITDA (pronounced e-bit-da) is earnings before interest, taxes, depreciation, and amortization. A normalized (or adjusted) EBITDA is the amount of earnings remaining after removing revenues or expenses that are atypical to the business.
To calculate, you take the EBITDA and add or subtract the adjustments (or anomalies).
This is a great metric to help you compare your valuation to other companies. Because you operate differently than the competition, normalized EBITDA evens the playing field, making your profits more comparable.
Ready to Improve Your Profitability?
By incorporating these into your financial strategy, you’ll be getting yourself one step closer to reaching your profit goals.
To ensure you’re tracking the right metrics, your numbers are correct, and to help you nail the implementation process, consider working with U-Nique Accounting.
We focus on doing what it takes to grow your business. Contact us today!