Profit vs. Profitability: What do Entrepreneurs Need

Ask any business owner what their aim for their business is, and the most common answer would be to earn more profit. Of course, expanding the business, enhancing their brand, and making a difference to society are some common goals – but all of these goals rely on profits. But what if we told you that just earning profits alone won’t help you achieve your business goals! They are important, no doubt, but there is one other thing that is just as important – profitability.

And while many people use the two words, profit and profitability, interchangeably, they are actually not the same thing. They are calculated differently and use different ways of measuring your business success. Let’s understand these two important terms in more detail.

Understanding Profit

What is profit? In the simplest terms, it is the money your business is left with after having paid all its costs: Total Revenue – Total Expenses.

For instance, if you earned $50,000 in a month, and the total cost for running your business and making your products or providing your services, including rent, salaries, utility bills, and more, came to $35,000, you’ve earned a profit of $15,000.

Profit is an absolute term. It gives you a concrete figure of how much you have earned in monetary terms over a specific period. This money can then be used as you like – to be reinvested in the business, to buy new equipment, to give a bonus to employees, or pay generous dividends to yourself.

Understanding Profitability

Profitability is a relative term that is measured as a percentage of revenue or capital invested. If profit gives you a specific number of how much you’ve earned over and above your costs, profitability enables you to make this figure comparable to last month’s, or last year’s, or even to the profit of your competitors. Profitability gives you a clear sense of how efficiently your company uses its resources. Are increasing sales improving profits? Is your profit as good as your competitor’s? It always takes a long-term view and indicates your business’s resilience to handle demand and profit fluctuations.

Gross profit margin, net profit margin, and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), Return on Assets (ROA), and Return on Investment (ROI) are all examples of profitability ratios.

A Scenario for Profit vs. Profitability

Jason has an artisanal ceramics business, which he set up for $40,000 and earned $52,000 this month – earnings a $12,000 profit! Meanwhile, Mathew invested $10,000 in a little ceramic store in the neighbourhood and made a profit of only $4,000 this month.

With a $12,000 profit, Jason’s business might look more profitable. However, Mathew is running his business more effectively because his ROI is 40%, compared to yours at 30%. Even if Jason sells more products, his profits will rise, but his profitability will not. This scenario shows that Mathew has a greater chance of surviving and even thriving during lean phases than Jason does.

A healthy profit gives you more liquidity to grab any opportunity that comes your way. It also helps manage your cash flow better and comes in handy in emergencies or when demand spikes, which may warrant extra production. A high-profitability business can help you stay profitable even during a crisis and make your business more attractive to investors.

Profit and profitability are both vital to keeping your business afloat in the short term and growing in the long term. Understanding their difference can help you avoid some common mistakes entrepreneurs make by confusing profit with profitability:

• Only focusing on increasing sales to make more profits, while ignoring profitability.
• Not including small or hidden costs such as delivery charges, maintenance costs, etc., while calculating profitability.
• Not cutting down on production or operational costs based on “high” profits.

If these tactics do not help improve profit or profitability, then what does?

Strategies to Improve Profit

To improve profits, you must do two things: increase your sales and reduce your costs. You can review and revise prices, offer discounts or membership points to loyal customers, and reach new customers through targeted marketing campaigns to increase sales. At the same time, measures such as cutting unnecessary expenses, improving operational efficiency, and sourcing suppliers at lower costs through local channels can go a long way toward reducing costs and increasing profits.

Strategies to Improve Profitability

Improving profitability is not just about increasing production, but also increasing productivity, i.e., improving efficiency and utilization of employees, resources, ideas, and technology to improve profit margins. For this, you have to:

• Emphasize high-margin sales – Instead of just selling more, focus on products with higher profit margins. Because selling more low-margin goods will not boost profitability, only profit.
• Increase Sales – While getting new customers is great, many entrepreneurs do not realize that every new sale comes with a customer acquisition cost. Instead, cross-selling or upselling more products to your existing, loyal customers is more pocket-friendly for your business.
• Reduce unnecessary costs – Productivity and profitability can only be enhanced when the costs also go down simultaneously. Regularly reviewing, analyzing, and eliminating unwanted costs, such as unused subscription fees, or cutting down on businesses where your sales are not gaining traction, can go a long way in saving on unnecessary costs. Wherever possible or essential, upgrade your production equipment and technological support to increase production and sales.
• Invest in technology – Using customized software to automate routine tasks such as billing, invoicing, and inventory management can give you and your staff time to focus on growth activities, save on utility costs, and reduce errors.

Increasing profitability requires strategic thinking and offers you scope to innovate. There is no magic formula for enhancing profitability with a single strategy. Understanding your customers’ preferences, observing and analyzing the market, and making the most of your available resources are the keys to unlocking your business’s full potential.

Why do Entrepreneurs Need Profitability?

Why are we stressing so much on improved profitability rather than profits, when we know that profits are also very important to any business? Because, as an entrepreneur, you want your business to thrive long-term. And this is only possible when, with time, you spread your horizon through new products and markets. When analyzing new opportunities, entrepreneurs should look at the profitability of the new venture rather than absolute profit. That way, you can expand your business even in a weak market.

Most of all, better profitability boosts investor confidence. A business that has high profit margins and ROI is attractive to potential investors. More investments give your business the financial strength and backing to do more sustainably.

Contact KSSP Partners LLP in Markham to Help You Improve Business Profitability

Though these strategies may sound easy in theory, they are not as easy to put into practice. Profitability requires extensive background research, data analysis, and number crunching to identify productivity and profitability drivers, which is where a business consultant can help. At KSSP Partners LLP, our accountants and business consultants can prepare financial statements, analyze profitability margins, and identify cost-cutting opportunities. To learn more about how KSSP Partners LLP can provide you with the best accounting and business consulting services, contact us online or by telephone at 289-554-5997.