Fix of the Week: Profitability
The Term and Definition:
Profitability is a measure of a company’s ability to generate sales and to control its expenses. It is one of the most commonly upheld benchmarks of a company’s success. A good manager’s job, regardless of their role, is to boost their company’s profitability.
Keep in mind that none of the numbers contributing to a company’s profitability is wholly objective. Sales are subject to rules as to when the revenue can be recorded. Expenses are often a matter of estimation. Assumptions are built into both sets of numbers. So profit as reported on the income statement, while certainly important, is a product of the art of finance and must be regarded as such.
Also note that that there is a big difference between profitability and cash. Companies can be profitable but have no cash (and vice versa). So a good manager needs to be aware of how both cash and profit interact.
Example:
Reference the following income statement for a very small hypothetical company.
As you can see from this example, there are only three possible avenues to improve profitability. One, the company can increase profitable sales (revenues). Two, it can figure out how to lower production costs and run more efficiently—that is, reduce COGS (cost of goods sold). Three, it can cut operating expenses, which almost always means reducing headcount. Of course, layoffs can backfire, so for most companies, it’s better to manage for the long haul and to focus on increasing profitable sales and reducing costs of production.
Book Excerpt
(Based on excerpts from Financial Intelligence, Chapter 4 – Profit Is an Estimate)Profitability is how you as a manager are likely to be judged. Are you contributing to the company’s profitability or detracting from it? Are you figuring out ways to increase profitability every day, or are you just doing your job and hoping everything will work out. (A) familiar saying, attributed to Laurence J. Peter of The Peter Principle, tells us that if we don’t know where we’re going we’ll probably end up somewhere else. If you don’t know how to contribute to profitability, you’re unlikely to do so effectively.
