“We expect all our businesses to have a positive impact on our top and bottom lines. Profitability is very important to us or we wouldn’t be in this business.” – Jeff Bezos.
Profit making is the motivation for starting businesses. Unfortunately, a lot of people motivated by profit making usually fail to make profit in business.
Most businesses don’t make profit because they don’t understand financial basics.
What is a profit?
A profit is the excess of total revenue over total cost at the end of a business period. Total revenue is the money a business earns from the sales of its products and services.
Total cost is the sum of all costs a business incurrs to produce a given level of output
What are the five key areas of cost and revenue that determine business profitability?
- UNDERSTAND THE COMPONENTS OF COST AND REVENUE.
A business that desires to make profit must understand the components of revenues and costs and best ways to maximize revenues and minimize costs.
These components are often either overlooked or not known by most entrepreneurs. Before explaining them, it’s important to mention that an entrepreneur must understand the matching concept that ties cost to relevant revenue. This means that no item of cost is assessed in isolation of a corresponding item of revenue.
In carrying out the assessment, available investment opportunities must be exhaustively analyzed to determine the most cost effective that promises the highest revenue yield This would require the understanding of costs and revenues.
Costs are made up of fixed cost and variable cost. A fixed cost otherwise known as a period cost is incurred within certain turnover limits for a business period. It’s unaffected by fluctuations in the levels of turnover. Fixed costs are time related and within limits.
A variable cost is a cost which varies with a measure of activity in the short term. This cost varies with changes in volumes of output. Why is it important to understand variable cost? To determine the amount of additional costs that would be incurred by increasing output by one more unit.
The understanding of how total costs are arrived at is fundamental to the determination of the break-even point, where total cost equals total revenue. It’s also a fundamental factor for the calculation of the profit margin. That is, by what percentage should total revenue exceed total cost in order to take care of delayed cash receipts and guarantee business continuity?
Total revenue is also referred to as the top line figure from which costs are subtracted to arrive at income. It’s obtained by multiplying sale with average product or service price.
2. UNDERSTAND THE MATCHING CONCEPT:
Running a profitable business requires the understanding of accruals and prepayments.
Accruals arise from credit sales and purchases.
Accruals are revenues earned or expenses incurred which cash related to the transaction has not yet changed hands. Accruals affect net income on the income statement and non-cash assets and liabilities on the balance sheet.
Prepayment is a payment in advance for yet to be consumed services or products. Accruals and prepayments must be matched to relevant accounting period. This is necessary for the accurate calculation of relevant periodic revenue and profit or loss.
Another important reason for matching costs incurred and revenues earned to a relevant period is for the purpose of determination of accurate tax figures.
3. PRODUCE A QUALITY FROM NEEDS:
A profitable business must make the volume sales that yield revenues in excess of costs.
Consumer buying behaviour is highly influenced by the quality of product or service. A business that needs to sell in profitable volumes must prioritize quality and specifications dictated by consumer needs. A profit focused business at all times, aim at filling needs
4. DETERMINE A PROFITABLE PRICING POLICY:
A business with a profit making objective must get its pricing policy right.
A business, depending on the market segment it’s targeting, may decide to introduce its product through the price skinming product pricing model.
The business may begin by charging consumers the highest initial price possible and gradually lowers it over time
Or it may use the price penetration product pricing model to get a lower priced product into many hands across many market segments.
5. DETERMINE APPROPRIATE MARKETING COMMUNICATION SYSTEMS:
The marketing communcatiins channels are another key factor that determines the profitability of a business.
Here, the choice of a channel would depend on a number of factors. These are the marketing budget, the goal of the business, the target customer, the product or service and the marketing information system in place for feedback.
These considerations should provide sufficient guide to help a business pick any or a combination of the following:
b. Personal selling and,
c. Sales promotion.