Profit = Revenues minus expenses. It's that simple!
So, let's dive in a bit more into the details of how to maximize this equation. Every business has Profit and Loss (P&L) statement that is generated at the end of each fiscal period. This statement is the fundamental document that lays out all the different variables that make up profit and loss for a business entity. Below are a few important variables/entries that are on the P&L statement that directly impact profit and loss.
IMPORTANT P&L VARIABLES
- Sales/Revenues
- Cost of goods and services (also known as COGS)
- Gross Margin (difference between sales/revenues and COGS)
- Other expense directly related to sales (such as direct labor, transport, shipping, supplies/parts needed to fulfill a sale)
- Occupancy/real estate/marketing/overhead/other costs and expenses
- Labor and payroll
- Vehicles/Transportation/fuel/utilities/supplies etc..
- Business services/fees
- Travel/meals and Administrative costs
- Insurance, fees and other miscellaneous costs that are incurred in running a business
When a business sells goods and services, this transaction generates sales which translates into revenue, the bedrock of profit creation and one of the biggest drivers of profitability. Some other important drivers of profitability related to sales are:
To support sales and revenues, a business has to spend money to make those sales happen, which are called operating expenses.
Typical P&L statement to illustrate how variables driven by sales and expenses influence profits
Sales/Revenues: Firstly, any profitable business needs to have solid sales performance that is consistent and showing signs of growth each year. Having the right sales and marketing strategy, customer centric approach, and top-notch products and services, in most cases results in meeting or exceeding sales needed to drive profits.
Gross Margins: Having robust sales is without question the bedrock of strong profits but making sure the cost of those sales (COGS) is as low as possible is key in making sure gross margins (sales minus cost of sales) are healthy. Selling the right assortment of products and services and pusiKeep in mind, to make a profit, a business needs to have enough gross margin left to cover operating costs incurred in running and operating a business. So if the sales are strong but if it does not leave a healthy enough margin, then operating margins will be either very thin and even negative, potentially creating a net operating loss situation.
Operating Expenses: These are expenses you incur in running and operating a business. Such as:
- Marketing and advertising
- Occupance, rent and real estate expenses
- Utilities, maintenance and repairs
- Payroll and labor expenses
- Transportation, fuel, shipping etc
- Technology, support services (legal/consulting and such)
- Insurance and fees
- Administrative, travel, meals, supplies and such
To calculate operating profit, you must subtract these operating expenses from gross margin, and then what remains, is operating profit. So, keeping operating expenses as low as possible will enable more dollars from sales to flow through to the bottom line as profits.
There are a few other expenses that businesses incur such as taxes, interest expenses, royalty expenses and such that are not part of the operating expenses but should be deducted from operating profit to calculate net profit.
So, to wrap it up. Increasing sales/revenues, selling the right product and services, expanding gross margins, and keeping operating expenses as low as possible are the keys to maximizing profits.
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