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What Is Profitability?

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  • Written By: Felicia Dye
  • Edited By: Heather Bailey
  • Last Modified Date: 23 June 2014
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Profitability refers to the potential of a venture to be financially successful. This may be assessed before entering into a business or it may be used to analyze a venture that is currently operating. Although it may be found that one set of factors is not likely to be successful or has not been successful, it may not be necessary to abandon the venture. It may instead be feasible to change operational factors such as pricing or costs.

There are three basic situations that can describe a business’ financial situation. It can be profitable, it can break even, or it can operate at a loss. In most cases, an organization’s goal is to make a profit.

When there is constant or abundant cash flow, it can be difficult to determine profitability. It is easy for a person to make the mistake of linking numerous incoming and outgoing transactions with profit. Spending and receiving money, however, does not mean a business is in a healthy financial state.

To determine profitability, it is necessary to access the price of the goods or services being offered. There are several things that need to be considered when prices are established. This includes variable costs such as fuel, labor, and inventory, and it also includes fixed costs such as mortgage, repairs, and taxes.

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Yield must also be considered. This refers to the amount of products or services produced within a certain time frame or from a certain amount of materials. For example, if a full tank of gas is only sufficient for two deliveries, the price is likely to be higher than it would be if a full tank of gas could accommodate six deliveries. If the price for two deliveries were priced the same as six deliveries, it is likely that profitability would be jeopardized.

Tracking profitability may require two things. First, a business will likely need good and accurate records of its expenses. Second, depending on the size and complexity of the venture, a person with good accounting skills may be needed to ensure proper calculations.

There may be a number of parties interested in the profitability of a particular venture. For example, sometimes people are owners of businesses but they are not operators, giving them a reason to be interested in the financial health and direction of the venture. Stakeholders who have money invested are also likely to be highly concerned with the profitability of a business. Employees, especially those at the managerial level, should also care because lack of profit can threaten job security and may damage a person’s professional reputation.

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Discuss this Article

latte31
Post 4

@Moldova - I agree. A company that focuses on ways to increase its profitability will tend to be more successful. This is really different than not for profit organizations that cannot earn a profit and any additional profits that come up have to be reinvested in the company.

For example, a credit union is a not for profit organization and it is owned by its members. Any profit that the credit union receives has to be reinvested and passed on to its members. They usually do this by offering more favorable rates on depositing products as well as mortgages.

This is why I have an account with a credit union because they tend to offer better rates on most loans than traditional banks.

Moldova
Post 3

@Suntan12 - I know what you mean. I used to go to fast food restaurants for breakfast and felt the menus were pretty bland. Now with the number of food choices along with the upgraded coffee options I feel that I can find something for my whole family in the same place.

I know this makes the fast food chain more profitable because breakfast items are cheap to put together. Coffee is especially cheap and probably has a higher markup than gasoline does.

These restaurants realized that coffee was a big deal and if they offered gourmet coffees at a slightly lower price than their competition they would be more profitable because of the sheer volume of customers that would come through the door would make up for the reduce price charged.

suntan12
Post 2

@Subway11 - I never thought about it that way and you are right. Businesses have to turn a profit in order to survive which is why the profitability management of a company is critical. I think that companies that streamline their operations and focus on the things that generate the most revenue will do the best in the long run.

Sometimes a company will test market a product or idea in a small market to see if it has the potential to be profitable in the rest of the country. I know that in order to stay competitive companies have to offer new products and services and this is a great way to test the market before spending too much on its promotion.

A lot of fast food restaurants do this from time to time. They will offer certain menu choices that are only available in a few cities. For example, years ago when the fast food chains realized the profitability of breakfast menus many of them began to offer lattes, cappuccinos, oatmeal, cinnamon buns, muffins, in addition to their current breakfast menu.

This was to take some of the coffee business away from a few major companies that dominated this market. In fact, in specialized markets like Miami, this chain was offering café con leche which is an espresso drink with milk popular in Latin communities like Miami.

subway11
Post 1

I just wanted to add that the profitability analysis will determine how likely a company is to turn a profit in the future. This is what I look for when I am considering buying an existing business.

I know that some people like to buy struggling businesses that are not profitable in order and buy at a great price and then resell the business at a later date at a much higher price once the business shows a profit.

I would rather buy something that is already earning net profits because if the business is not profitable it may be that the particular business model or idea is not lucrative enough.

This is also the advantage of buying an existing business than starting one from scratch because with an existing business you can see the financials and know if the business is profitable or not while with a new business you are hoping it will be.

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