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The first profitability ratio we’re going to look at, is the one you likely already know and love –
Gross Profit %
The question is, do you look at this regularly? I’m going to guess that most small business accounting professionals only look at this t yearend. In fact many CPA’s I’ve worked with, use this as a benchmark for comparing current year to prior year, just to look for anomalies. If they find them, then they dig in, and start asking questions.
Most do not even explain to the client, how they came to the conclusion that a deeper look was needed in these areas. Imagine how much value that would have, if you took the extra five minutes at yearend to explain to the client what you did, and why, and how it can help identify problems, so that you can implement the solutions. It could be a bookkeeping error, which I think is what the CPA’s and EA’s who do this are looking for. It could also indicate a problem, or if the ratio improved dramatically, it could mean management did something really well.
Your client would value you, ten times more (which means you could increase your rates by 2X and be worth 5 times your rate in the eyes of your clients. All you have to do is spend a little extra time explaining these important ratios to them.
Once a year is not enough. Work with your clients monthly or quarterly, and charge them for the “strategic consulting.” This is what clients want, but aren’t getting from their CPA’s and EA’s.
Don’t believe me?
Check this out –
Next let’s look at some other important measures of profitability.
EBITDA % Margin
Investors often consider debt, and interest, as well as non-cash expenses such as depreciation and amortization to be an undue burden on a company. They want to see how profitable is the company without these things?
Operating Margin is a measure of well a company has priced their products and services, as well as how efficiently the company has operated.
The calculation is simple –
Operating income / Net Sales
Operating margin measures what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc.
“Operating income” is the profit that a company retains after operating expenses (such as cost of goods sold and wages) and depreciation.
“Net sales” is sales minus returns and allowances.