Profitability analysis is the process of comparing income to output and determining how much profit was made during a specific time period. This activity can help business owners determine the effectiveness of a marketing campaign, identify expenditure areas that may need to be reevaluated and decide the viability of the business as a whole. A whole-business profitability analysis may be required to secure new funding, either through loans or the attraction of investors.
When completing a profitability analysis, it is first important to identify all costs. This includes hard costs such as supplies, buildings, utility bills, advertising payments, salaries, and so forth. It also includes soft costs such as the cost of capital.
People often forget to include the real cost of labor when analyzing a portion of a business, such as a specific project. The real cost includes not only the employee’s salary, but also her benefits package. In large companies, this real cost number is often available from the human resources department.
Once all costs have been identified and gathered, the individual conducting the profitability analysis must collect information on income. Sources of income can include sales, royalties and collected rents. Total income minus total expense yields profit.
Some companies do not consider themselves to be profitable unless income is greater than output by a pre-determined percentage or dollar amount. This is usually because those companies are accounting for reinvestment dollars. In this business model, a set percentage of profit dollars is always allocated for reinvestment in the business, often to purchase new equipment, update technology or purchase real estate.
A profitability analysis can be used in many ways. For example, a small business may place a coupon in the local newspaper. To determine whether the coupon was profitable, she will need to compare the cost of the advertisement, plus the amount of money discounted to the amount of new business brought in by the coupon. This will tell her if the campaign was profitable and help her determine whether or not to do it again.
A business seeking a capital infusion may need to complete a profitability analysis to secure funding. Banks are more likely to lend money to a business that can show a strong history of profitability. Investors may also be more likely to invest money with such a business.
All businesses that are publicly-traded must provide stockholders with a profitability analysis on a pre-determined, scheduled basis. Often, this occurs annually. Businesses that are governmentally funded must also provide such analyses.