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Is your business profitable? To find out, you only need
a few simple calculations. Increasing profitability in a company whose ratios are
declining is much more difficult. Although improving profitability may require
many changes, the process benefits the business. How do you calculate
profitability and what can you do to improve it?
How can you improve business profitability?
Accounting that understands your business
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What is profitability and what affects it?
Profitability is a financial measure reflecting a company's ability to generate profit from its operations. It shows how profitable your business is and is among the most important measures of financial and operational performance. Profitability is an important financial analysis tool for sound decisions. Analysing it can identify activities that generate profit and those requiring changes.
Profitability means the ratio of profit to sales, assets or capital:
● ROS (return on sales) measures a company's profit relative to sales; ● ROA (return on assets) measures the ability to earn a return on investments; ● ROE (return on equity) measures profit on equity contributed.
These measures focus on different aspects of business and have no fixed target level. Compare them with competitors' results, industry averages and changes over time.
How do you calculate company profitability?
You need basic company financial data to calculate profitability. The calculations are straightforward and provide valuable information on the company's condition.
Calculating return on sales (ROS)
ROS is net profit divided by sales revenue. The result shows how many groszy of profit the company generates from each zloty of revenue. Return on sales should remain steady or rise; an increasing ROS indicates greater financial efficiency.
Use this formula for return on sales:ROS = (net profit / sales revenue) × 100%
Example: A company earned PLN 500,000 in sales revenue in 2023. Its total costs were PLN 350,000. Subtracting costs from revenue gives net profit of PLN 150,000.ROS = (150,000 / 500,000) × 100% = 30%
The result means 30 groszy of profit per PLN 1 of sales.
Calculating return on assets (ROA)
ROA shows the extent to which the assets held can generate profit, making it possible to measure the effectiveness of resource management.
Return on assets formula:ROA = (net profit / total assets) × 100%
Example: A business owner opened a second branch in another city and spent PLN 50,000 on it. After a year, net profit was PLN 37,000.ROA = (37,000 / 50,000) × 100% = 74%
The owner earned a profit of 0.74 grosz for each PLN 1 of invested capital.
Calculating return on equity (ROE)
ROE indicates how much profit is earned for each unit of equity, that is, the value of company assets contributed by the owners and funds accumulated in the course of business.
Return on equity formula:ROE = (net profit / equity) × 100%
Example: A business owner opened a clothing shop and invested PLN 50,000 of equity. After a year, net profit was PLN 35,000. ROE = (35,000 / 50,000) × 100% = 70%The owner retained the profit, raising equity to PLN 85,000. The next year's net profit was again PLN 35,000, but return on equity fell:
ROE = (35,000 / 85,000) × 100% = 41.18%
Why analyse company profitability?
Regular profitability analysis is the simplest way to understand a company's current financial condition. Its benefits include:
● support for strategic decisions and goal setting, ● support for planning and forecasting growth, ● assessing how effectively revenue becomes profit, ● identifying areas that need optimisation, ● investment success (investors and shareholders analyse profitability), ● better risk management, ● spotting excessive costs and managing resources better, ● opportunities to save in specific identified areas, ● effective use of resources, ● ongoing monitoring of financial performance and strategy effectiveness, ● greater credibility and creditworthiness (banks analyse company profitability, and stable profitability brings better financing terms), ● building competitive advantage and the ability to remain in the market.
How do you improve company profitability?
There are many ways to increase profitability. Of course, before making changes, you need to identify areas that require optimisation. Here are several suggestions for improving business profitability.
1. Optimise operating costs
Reducing costs strongly affects profitability. Analyse operating costs and identify where they can be reduced.It is important to cut costs without reducing product or service quality. Activity-based costing (ABC) can help measure indirect costs more accurately across products and services.
Areas worth considering:
● Suppliers: try renegotiating terms for a better deal; if unsuccessful, consider switching suppliers. ● Production: see if you can reduce waste and improve processes through technology that shortens production time, increases efficiency, lowers labour costs and reduces staff positions. ● Premises: rent a smaller space, use your current space better or sublet unused areas. ● Finances: do you constantly track your finances and use banking products on the best terms?
One way to optimise costs is to work with an external accounting firm instead of employing an accountant or running an in-house HR department.
2. New communication channels
To reach new customers, open up several communication channels. In particular, build visibility online: a website, social media and online advertising tools. You can assign the work to a marketing agency using modern tools. A company blog, like the TaxCoach blog, can attract customers interested in the subject. More traditional advertising, such as TV, banners and flyers, can also increase visibility. If you operate in e-commerce and sell through your own online shop, selling additionally on marketplaces like Allegro, Amazon or eBay may boost profitability.
3. Invest in customer service
Satisfied customers are more likely to return, so find ways to retain them. Options include attractive loyalty programmes encouraging repeat purchases, discounts on future purchases, free-shipping codes, discounts for reviews, up-selling (offering more expensive products with better features) and cross-selling (offering complementary products). Provide a mobile-friendly website, several payment options, clear purchase and return conditions and easy contact through chat or social media to keep customers satisfied.
4. Reduce losses and waste
Almost every company can identify activities causing unnecessary costs. They are found everywhere, from energy use (for example, equipment or lights left on) to overproduction and transport. We also waste time through too many procedures or outdated methods. A dental practice that confirms appointments by phone, for example, could speed up the process by using a system that sends patients automatic texts, saving time and lowering telephone bills.
5. Optimise accounting policies
Appropriate accounting policies give essential information on financial measures needed to find areas for change. Proper business financial management requires planning, organising and monitoring financial resources. It includes budgeting, liquidity management, cost control and profitability analysis. Financial management is paramount to maintaining long-term stability and business growth.
How can TaxCoach accounting firm help manage finances?
● Accounting: the firm keeps books and handles taxes and offers accounting services tailored to the business. ● Financial reporting and analysis: preparing detailed financial reports covering profitability, liquidity and debt ratios. Financial data can be analysed by department, product or customer, clarifying which areas are most profitable and which need improvement. ● Budgeting and forecasting support: an experienced accounting firm can help business owners prepare budgets and financial forecasts. ● Internal audit and advice: an audit by an accounting firm helps identify financial risks and areas needing improvement. Tax advice helps identify tax risks, minimise burdens and ensure legal compliance.
6. Train and develop employees
Staff skills are also very important for profitability. If you want to invest in innovation and rank among the best firms in your sector, invest in employee development. Training improves skills, raising work efficiency and quality, while new skills enable quicker work and better team management. Many employees want to grow personally, so training raises motivation, loyalty and engagement and reduces turnover; it also improves the company's reputation and prestige. In a fast-changing business environment, training helps prepare for technological, market and regulatory changes and makes employees more receptive to innovations. Training also supports communication and teamwork; despite its cost, it may save money over time, reduce errors and turnover, and raise productivity, engagement and knowledge. Incentive schemes, bonuses and rewards can further encourage skills development and higher performance.
7. Monitor results regularly
Improving profitability requires continuous performance monitoring. Entrust financial analysis to an experienced adviser with the necessary knowledge and tools. Benchmarking is particularly important: it compares a company's performance with competitors. This can reveal effective practices to implement in the business.
If you found this article interesting, explore our chief financial officer services and read how we can help you:
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