Every business strives for profit growth, but they experience it at different rates. Only the highest-performing companies post consistent profit growth over some time.
Profit growth is a good indicator of your business’s financial health. If you’re not growing, it’s time to look for the underlying causes. Although some aspects of the overall economy are sometimes out of your hands, how you react makes a huge difference.
Keep reading for a few tips on finding growth in your accounting reports!
What Is Profit Growth?
Profit growth is a measure of the company’s financial performance over time. Measured both as the percentage change or in absolutes, it helps compare a company’s performance against itself or similar companies. That determines whether its performance is above or below average.
Calculating profit growth is as simple as taking the current year’s net income and dividing it by last year’s net income. For example, if net income increases from $1 million to $1.2 million, you’ve achieved 20% profit growth, and cash flow growth is the same.
How To Measure Profit Growth
Profit growth is a crucial indicator of financial success since it confirms that you’re earning more money than you spend, but you’re also increasing that amount.
There are several ways to measure profit growth:
Margin or Profitability Ratio
Margin or profitability ratios measure a company’s ability to generate profits. To compute, divide the net income by sales; the higher the number, the better.
The most common margin or profitability ratios are:
- Gross Margin Ratio: Gross profit divided by sales (gross profit/sales). This ratio measures the portion of sales amount remaining after paying direct costs. It’s also known as gross profit margin or gross margin.
- Operating Profit Margin Ratio: Operating income divided by sales (operating income/sales). How much money the company generates after paying all operating expenses but before paying taxes and interest on loans or other debts.
- Net Profit Margin Ratio: Net income divided by sales (net income/sales). The measure of what’s leftover after expenses, including taxes and interest on loans or other debts. These payments reduce the total available for distribution as dividends to shareholders.
Break-Even Analysis
Break-even analysis is a financial tool for determining when sales equal costs. In short, it’s what the company must sell to recover all costs.
The formula for calculating break-even is as follows:
Sales – Variable Costs = Contribution Margin
Contribution Margin / Break Even Sales = Break Even Percentage
Return on Assets and Investments
Return on assets (ROA) is a financial ratio for measuring a company’s profitability and appears as net income divided by total assets. The formula is as follows:
ROA = Net Income / Total Assets
Return on investment (ROI) is similar to ROA but considers the capital invested in a business instead of the total assets. ROI is the net operating profit before taxes (NOPBT) divided by net value. The formula is as follows:
ROI = NOPBT / Net Value
Profit by Segment
Another way to measure profit growth is by segment. In addition to measuring overall profit, it’s always helpful to compare the current period’s earnings with previous periods. You’ll want to regularly analyze these numbers to determine if there are any changes in your business over time.
You may find that an increase in one area is causing a decrease in another. It could help you identify areas where you need to make improvements or changes so that they don’t negatively affect your bottom line.
Profit Growth Requires Good Accounting
Accounting is the language of business, and it’s how you communicate with your customers, employees, investors, and suppliers. If your numbers aren’t correct, you could lose business opportunities and waste time chasing down mistakes that wouldn’t exist if your numbers were reliable.
Good accounting also gives you a robust basis for making decisions.
The ability to drill down and identify which aspects are going well and which are not performing helps you focus on the most critical issues. An essential element of consistent profit growth requires solving the problems with the most significant, fastest payback first.
A common mistake many small businesses make is not having an accounting system in place. Without an accounting system, it’s difficult to track expenses and revenue reliably over time. It is even harder to understand how changes in expenditures or revenue impact profits and losses over time.
Experience Profit Growth With the Help of Founder’s CPA
Profit growth is a significant financial measure of success. It can reveal how well a company is performing, its prospects, and whether it’s worth investing in. Monitoring profit growth carefully can also serve as an early-warning indicator when things aren’t going as well as possible.
A company with rising profits has a bright future, and Founder’s CPA is your go-to partner in finding and measuring your profit growth. Contact us today for a free consultation.
