What is profitability analysis?

Profitability analysis is the process of comparing revenue with production and determining the amount of profit made during a specified period of time. This activity can help business owners determine the effectiveness of a marketing campaign, identify areas of spending that need to be reassessed, and decide the viability of the business as a whole. A company-wide profitability analysis may be necessary to secure new financing, either through borrowing or attracting investors.

When completing a profitability analysis, it is important to first identify all costs. This includes hard costs such as supplies, buildings, utility bills, advertising payments, salaries, etc. It also includes light costs such as the cost of capital.

People often forget to include the actual cost of labor when looking at a part of a business, such as a specific project. The actual cost includes not only the employee's salary but also their benefits package. In large companies, this actual cost number is usually available from the human resources department.

Once all costs have been identified and collected, the person responsible for the business case needs to collect revenue information. Income sources can include sales, royalties, and collected rents. Total revenue minus total expense produces a profit.

Some companies are not considered profitable unless revenue is greater than production by a predetermined percentage or dollar amount. This is usually because these companies are counting reinvestment dollars. In this business model, a set percentage of profit dollars is always allocated to reinvest in the business, usually to buy new equipment, upgrade technology, or buy real estate.

A profitability analysis can be used in several ways. For example, a small business might place a coupon in the local paper. To determine if the coupon was profitable, you'll need to compare the cost of the ad plus the discount amount to the amount of new business generated by the coupon. This will tell you whether the campaign was profitable and help you determine whether or not to do it again.

A company seeking a capital injection may need to complete a profitability analysis to secure funding. Banks are more likely to lend money to a company that can show a strong track record of profitability. Investors may also be more likely to invest money in this business.

All publicly traded companies are required to provide shareholders with a profitability analysis by default and on a scheduled basis. This often happens annually. Government-funded companies must also provide these analyses.

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