Why Profit Is Different From Turnover

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The major purpose of most businesses is to make a profit.

The amount of profit is represented by the increase in the net assets (total assets less total liabilities) of the business during the time the profit was earned. The aim is that those assets will eventually be converted to cash which will enable distributions to be paid to owners of the business.

The amount of profit which a business earns is also a major factor in establishing what the business is worth. This will be reflected in the selling price which can be achieved when the business is sold.

So the art of business is to do what it takes to generate profits.

In simple terms, profit equals sales less the cost of making those sales. These costs include the cost of raw materials, and direct and indirect expenses, including labour costs.

Turnover is naturally of prime importance, but they need to be profitable sales.

Some businesses like supermarkets, achieve their profits by very large turnover with relatively small margins ie there is not a lot of difference between sales of individual items and the costs of making those sales.

Other businesses, like speciality stores of services, make their profits on smaller turnover but with higher margins.

For most small to medium sized businesses, the margin is critical. If you give discounts to achieve greater sales, then this will erode your profit margin.

As an example:

Your normal selling price for an item is $100
You make a gross margin of 40%.
Your gross profit is normally $40 which goes towards paying overhead expenses and generating a net profit.
However to try and attract more sales, you decide to offer a discount of 20%.
Your gross profit is thereby reduced to $20 which is a 50% reduction to normal.

 

If you have different product or service lines, it is always worthwhile doing an analysis of the margin which each product range of service is achieving. We sometimes see, to the surprise of proprietors, that profits are being generated by one or two lines only, and these lines are supporting other lines which are not making a profit at all.

So discounts can sometimes be given for strategic purposes, but understand the effect they are having on profit. Generally it is much better to concentrate on providing great levels of service or quality, and marketing your “unique selling proposition” which is how marketers describe the particular feature of your business which your opposition doesn’t have (or doesn’t promote themselves as having).

By being effective in this, you will retain your margins, or even increase them by being able to raise your prices. You will look to increase your average sale per customer, and/or increase the number of times they buy from you. This way your sales will generate profits, and this is the goal.

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