Why Businesses Analyze Profit Reports
In this post, we'll discuss why businesses analyze profit reports and how to do it effectively.
Published July 31, 2022.
Profit analysis is the process of analyzing financial data to determine whether a company is making a profit or losing money. It is usually performed after the end of each accounting period but may be done periodically throughout the year.
Importance of Profitability Analysis
Business owners use profit analyses to determine if their companies are profitable or not. This type of analysis is often done to help organizations make strategic decisions regarding growth strategies, market-entry, and customer retention. In addition, it is useful for determining whether the current strategy is working or needs to be changed.
The goal of profitability analysis is to provide insights into the following:
- How much money does the organization generate per unit sold?
- What percentage of sales come from repeat buyers?
- Which products/services bring in the most profit?
- Which products and services are losing the most money?
How to Analyze Business Profitability
There are three main steps involved in performing a profitability analysis:
Step 1: Calculate Gross Margin
Gross margin is the percentage of revenues earned before deducting any expenses. For example, let's say that you sell widgets for $10 each. Your gross margin would be 10%.
Step 2: Calculate Net Margin
Net margin is the percentage of sales less all production and distribution costs. Let's say that you spent $100 to manufacture 100 widgets. Your net margin would be 90% since the remaining 10% was lost due to manufacturing costs.
Step 3: Calculate Return on Investment
Return on investment is the amount of money generated by a business compared to the amount of money initially invested into the business. To calculate ROI, divide the net income by the initial capital invested.