Net Profit Margins
This is a useful way to measure the performance of the business. It's part of ratio analysis and reflects the level of profit. It examines the profit when overhead expenses have been deducted and the level of sales revenue or turnover which the business generates.
Net profit margin = Net profit/ Turnover x 100
In the net profit calculation various businesses tend to calculate it differently from the above in order to account for the interest and taxation.
Net profit margin = Profit before interest and taxation/ Turnover x 100
Both show the business stakeholders the profitability of the business.
Return on Capital
This is a measure of the net effect of an investment of the business on its profit and overall efficiency. It's the expectation of a business that when it makes investments in the business, that such investments will yield positive returns. The formula is:
Return on capital= Annual return/ Original investment x 100
A business makes an investment of 25000.00 on machinery. It figures out that this would lead to sales increase of an extra 10000.00 hence the return on capital ROC is.
Return on capital= 10000.00/25000.00 x 100
Return on Capital = 40%
The first full year of such an investment has been profitable to the business.
Methods of Improving Profits and Profitability
There are several ways to improve profits and profitability. Businesses endeavour to see that overall costs are reduced and managed. This is because the higher the business costs, the lower will be the profit to the business. Therefore the profitability of the business will also be questioned.
Gross profit, Net profit, Retained profit and Disposable profit.
Whichever type of profit mentioned, the idea of profitability is to minimise expenses of the business which in turn leads to generation of higher profits in return.
In reducing business costs, all aspects of the costs of business must be accounted for. From the fixed costs to the variable costs all these must be properly managed for profits to be made and profitability to be shown.
Inflation and rises in prices of products can affect the profits and profitability of the business. Lower prices generally increases demand for products and there's more profit made by the business. The converse effect applies when price rise.
Differentiating between Cash and Profit
Cash and profit can be mixed together as having the same implications on the business. However, this is not the case.
Cash is the ability of the business to cover its expenses in a timely manner. It could be obtained from cash in flows, cheques and cash, as well as cash out flows.
When cash is built up by a business, there is a strong reserve in cases of emergency, which ensures the viability of the business.
Profit is the made through business cash in flows. When the expenses incurred by the business are deducted from the sales revenue, then the remainder is the profit of the business. It's calculated often quarterly, monthly or annually. Money borrowing, long term deposits, and money which customers owe can eventually become business profit. This is because they're not instantly available to the business.