Turning a profit, positive cash flow, financial gain and in the black are all terms for making money. And the best motivator for keeping your business open. However, wading through data to determine profitability can be tricky, but increasing profitability means you must define your profit points.

The Business Dictionary defines profit point as-  A Point in time (or in the number of units sold) when forecast revenue exactly equals the estimated total costs; where loss ends and profit begins to accumulate. This is the point at which a business, product, or project becomes financially viable.

In a Nutshell, your profit point is the amount of money you need to cover all the costs it takes to provide your product or service. Numerous offerings mean different profit points for each product you provide. If you buy something for 10 dollars and sell it for 20, we call it a mark up (of 100%). If we buy something for 10 dollars, but it takes 5 more dollars in costs before we sell it, we call it a profit margin (of 5 dollars).

Regardless of the terminology used, there are 4 basic ways of increasing profitability

1. Increase the price you charge for your various offerings.
2. Lower the costs of providing your products/services
3. Increase the number of offerings that you provide (sell more).
4. Eliminate things that are not making you money.

Increasing profitability by Determining costs:

Here are a few ways to break down the cost of doing business:

• Direct Costs: Money it takes to provide the product/service (inventory, material, wages, etc.)
• Indirect Costs: Money it takes to keep the business going (office, insurance, accounting, etc.)
• Fixed Costs: Costs that don’t vary or change (rent, labor, vehicle payments, etc.)
• Variable Costs: Costs that vary and change as your production changes (utilities, direct materials, commissions, etc.)
• Cost of Goods Sold: COGS = Beginning Inventory + Purchases during the period – Ending inventory. This formula is more for retail/wholesalers, but COGS could include costs like raw materials, storage, factory overhead, depreciation, service fees, transportation, etc. Basically its the costs you pay for the things you sell (or services you provide).
• Gross: Profit: Revenue – COGS.
• Net Profit/income: Definitions vary, depending on your accounting method.  But basically it’s the income left over after all your business expenses are deducted from revenues. AKA the bottom line. As a sole proprietor, this is the amount that goes to you, of which you now must pay your personal taxes. For corporate entities, this amount rolls over as your starting balance for the next year’s financial statements.

The formula for determining profit points changes product to product and service to service. Generally, they are taken as a whole as per this formula

Company Profit Point = Direct Costs + Indirect Costs = amount you need to bring in to break even.

Unit Profit Point = Direct costs + % of indirect costs that go into providing the product or service. (These take a more complete analysis that’ll be covered later in the series.)

For the small business, it’s best to start by determining your overall companies profit point. Again this just means your break-even point, or the point you stop losing money and can begin to make money (turn a profit).

Example of Determining costs

When I started my building repair company (focusing on residential and commercial units), I wanted it to run like any professional service company. I decided to go against the typical “handyman” outfits that worked by the hour and relied on cutting corners to turn a profit. At this time, computer software was new and expensive. But I knew the high cost of an earlier version of Quick Books was what I needed to track everything. Then after a year, I had enough records and transactions to start estimating my costs.

First, we separated the direct costs from my indirect costs.

My Indirect Costs = (rental fees + insurance + office costs + salaries + auto expenses + advertisement + 15% overhead) divided by my 22 days of operation each month.

Indirect costs = $6000 per month / /22 days) = $272.73 of indirect costs each day of operations.

This meant I needed to profit at least 272.73 every day I worked, just to cover my operations. But it didn’t stop here, because I still had the direct costs that needed to be added to these indirect costs to ensure I could turn a profit.

My Direct Costs =  (Inventory used per job + any special product/supply costs for each job + 10% overhead cost).  Since I performed multiple jobs per day, it meant designing a specially written system to track expenses at each job site.

By keeping a running record of my direct costs for various services, I was able to easily estimate what it took to perform my various repair tasks. By my second year, I was able to know how much to charge for any given job, that covered all my direct and indirect costs including a nice profit. If I’d just stuck to the per hour charge (plus supplies) I’d never made enough to turn a profit. With this system, I was able to expand my operations, income and profitability for 8 consecutive years. And drive around in one awesome vehicle.

6 Ways to determine pricing

1. Recommended Retail Price: These are set by the manufacturer/distributor
2. Competitive Pricing: Charge prices similar to competitor’s products.
3. Cost Plus: Adding a set amount to your cost.
4. Value-Based: What you think people are willing to pay.
5. Per Hour: Charge customers per hour of labor.
6. Highest or Lowest Cost Provider: Setting a high price may indicate superiority and set you above competitors (if you have provide true quality).  A low price may indicate a lack of quality, but help reach price-conscious customers.

Increasing Profitability in a nutshell

• If we want to keep a business going, it must make money.
• To make money, you must charge a price greater than it costs to provide your product/service and all your business expenses.
• If we want to know what to charge, you must know what it costs to do what you do (direct costs) and what it takes to keep you going (indirect costs).
• To reach profitability you must be able to charge more than your companies overall profit point.
• You can increase profitability if you can charge more for every single product or service you provide (reaching peak profitability).
• To charge more, you must be able to prove the value of your products to your customers (think marketing).
• Determining your profit points for everything you do is a vital step in increasing profits (or you will constantly underbid and undercharge for your services).

In the end, the other say to increase profits is to lower expenses as noted in part two.