Where do your profits come from?

February 8, 2012

When I look at a company’s profit and loss account the way my brain works is that I immediately look to the net profit figure, then to the sales figure and calculate the net profit margin. I would then look at the gross profit (the profit after direct expenses) and calculate the gross profit margin.

At this point, I basically know two things – firstly, the amount of money the company is making as a % of their sales and secondly, the amount of money the company is making after their direct costs.

The one thing I have no idea about is where the profit is coming from.

I usually do this exercise within 15 seconds of looking at the profit and loss account but unfortunately this is the extent of financial analysis of the majority of smaller businesses. The company is likely to be making a profit almost by accident or as an output of cost control and their price. This isn’t a bad thing, the company IS making a profit but without the understanding of HOW, the company is unable to pull the levers that will drive higher profits.

Truly identifying where the profit is coming from can be a complicated process depending on the size and complexity of the business but here’s a couple of tips that go beyond my 15 seconds of analysis…

1. Get a detailed listing of your sales and analyse it to death – number of customers, number of transactions, highest spending customers, lowest spending customers, sales by month, average sales per customer, average sales per your top 20% of customers

2. Look at all your expenses and identify the ones that truly relate to revenue generation i.e. direct costs. These are the costs that have to happen otherwise there is no revenue. Examples could include: team costs, materials, subcontractors etc. See how easy it is to allocate these costs to specific forms of revenue or customers.

These are a couple of simple steps, if you would like to have some more information on how to get under the skin of your numbers and truly understand where your profit is coming from, contact me at russell@rsaccountancy.co.uk

0113 337 2130

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