Following the Dollars
Dec 26, 2014 11:50 AM
We are almost a month into the New Year. How is your profitability tracking so far?
Balancing these demands can be challenging. Between the balance sheet, income statement, cash flow statement, and other financial documents, it might be tough to know where to look to truly define the profitability of your business.
The Big Three
To begin understanding profitability, you need to know these three figures:
• Gross margin
• Net income
All of these figures speak to your business’s profits, but in a slightly different way. Gross margin, which you’ll hear called gross profit as well, is how much money you have after you’ve taken out your direct costs for products and services. You want a high margin. It means you have more leftover to take care of your other expenses such as indirect costs and overhead. A low gross margin means you might not actually earn much after paying salaries, rent, utilities, and other business expenses. That’s also a signal that your pricing isn’t correct.
EBITDA, which is the fast way of saying earnings before interest, taxes, depreciation, and amortization, is an optimistic means of reporting your profitability. It’s your operating profit, which is your revenue minus costs of goods sold and operating expenses, with depreciation and amortization—usually found on the cash flow statement—added back in.
Net income is what people mean when they say the bottom line, and it’s very important to track. You should be able to do this easily with your up-to-date income statements. This is the figure you come to after subtracting all expenses from your revenue. What you have left is literally what’s in your ledger to move your business forward. If it’s a negative number, you’re operating at a loss.
The gross profit margin is your gross profit divided by revenue. It shows your ability to make money on the products and services after your cost of goods sold is accounted for. You’ll also need to know the industry norm for gross profit margin to understand if you’re in a healthy range.
The quick ratio is also important, and is calculated by taking your cash plus accounts receivables divided by accounts payable. This figure lets you know how much money you have to pay your bills and it should be at least 1-to-1. If you avoid risk, work toward a ratio of 2-to-1.
The debt to equity ratio is also crucial. An excessively high amount of debt compared to equity in the business is risky.
Ready for an even deeper dive into what it looks like to track the dollars? CEDIA has an entire business toolkit webinar series, developed with Leslie Shiner, to help tackle the business issues. In fact, there is an entire webinar and accompanying white paper on Tracking True Profitability and both are free to CEDIA members. Check out all the resources available in the CEDIA Training Catalog at cedia.net/training.