Three Equations for a Healthy Business

Recently, I had a chance to go through a management training program offered by Skillnets and delivered by ActionCOACH called ManagementWorks.

They gave us a definition of a business as

A commercial profitable enterprise that works without you.

So I went on thinking, yes that’s a good definition but how many people know how to calculate the profitability of the business. Yes a lot of ERP Systems that we provide can give you this figure on the click of a button but it is important to understand the equations behind this as well.

So here are my three equations which may help you understand the position of your business better and may help you understand how an ERP system for your business should give you figures.

Gross Profit Margin

The first calculation is the gross profit margin for your organization. This might get boring for a minute, but try to stick till the end.

Gross Profit Margin = (Sales – Cost of Goods Sold)/Sales

This number will tell you how efficiently you are utilizing your factors of production. A higher margin is a higher profit indicator.

Gross profit margins can vary drastically from business to business and from industry to industry. Financial-Projections.com gives you Gross Profit figures for various industries. They range everything from 11% to 93%. Check what is the Gross profit for your business and is it above or below the industry standard.

What should go in the landed cost of goods is the total of all the expenses that you have to do in order to get the good landed in your warehouse. This should include expenses such as shipping costs, packing costs, customs duty etc. This generally doesn’t include things like employee costs and other items which are not impacting the product itself.

Operating Profit Margin

While Gross profit margin is a useful figure. A lot of other items impact your operating profit margin for example, salaries, rents, contractor costs etc. In simple terms,

Operating Profit Margin = (Earning before interest and taxes)/Sales

This ratio is a rough measure of the operating leverage a company can achieve in the conduct of the operational part of its business. It indicates how much earning before interest and taxes are generated per EUR/GBP/INR/USD of sales.

High operating profits can mean the company has effective control of costs, or that sales are increasing faster than operating costs. Positive and negative trends in this ratio are, for the most part, directly attributable to management decisions.

Operating Profit Margin uses Earnings before Taxes etc also called, EBIT or EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization).

Net Profit Margin

Last equation in today’s blog and one of the most important one is Net Profit Margin.

Net Profit Margins = (Net Profits after Taxes)/Sales

Often referred to simply as a company’s profit margin, the so-called bottom line is the most often mentioned when discussing a company’s profitability.

Calculation of Net Profit Margin is generally easy. As long as you have entered all the expenses properly in your excel sheet or accounting software like Zoho Books or a sophisticated ERP system like Microsoft Dynamics 365 or Odoo.

To be honest, the tool is irrelevant in this case. But yes some of the tools make life easier by providing an easy to use interface to enter the data and have all the options available to calculate the three values of Gross Profit Margin, Operating Profit Margin and Net Profit Margin.

The best part of all of these software is that they can be modified according to your business requirements. Moreover, these ERP software help in streamlining all your business processes giving you the maximum visibility and control, they assure you more return on investment by integrating sales, warehouse, manufacturing and service functionality for streamlined, end-to-end financial management.

Let us know your thoughts on this article by leaving comments in the box below. We look forward to discussing this further with you and if you need any help in achieving a Healthy business. Do contact us at info@targetintegration.com



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