Computing Business Profitability
The bottom line goal of any business venture is to make a profit. Computing business profitability is the key to understanding how well this goal is being met.
Computing Business Profitability
The word computing used to be defined as being the same as calculating. It was a mathematical function that involved adding and subtracting functions. It was an often slow and detailed process that was nevertheless necessary to understand the profitability of the business. Computing business profitability has been made easier today with the advent of computer business software. Although the computer has made computing easier, the basic principles remain the same.
Many new entrepreneurs mistake cash flow and profitability. The two may seem similar and the rapid inflow of cash is very heady to the new businessman. However, profitability is not totally based on cash flow. It is actually the bottom line of a computing process that involves a complete accounting of expenses. Regardless of how much income is generated, the expenses that are paid to produce this income must be subtracted to determine the true profit of the business.
It is important to understand this principle in order to truly understand profit. When a business receives a loan, for example, there is a sudden increase in cash flow, but this is not profit. When a reduced price clearance sale is held, this could generate a great deal of cash flow, but it is not profit either. In the case of the loan, it is actually just a transfer type transaction. The cash received from the loan is balanced out by the liability of the loan repayment. In the case of the clearance sale, if the cost of the products sold exceeded the sale price, the net result is actually a loss rather than a profit.
The computer has opened up some opportunities in business forecasting. Programs exist that can show the impact of a change in operating procedures on profitability. These are called business models and they allow you to tweak a certain factor, such as sale price, and see the impact on future profitability.
So, the process of computing profitability can not only serve accounting purposes, but can also be used as a planning tool to guide decisions and facilitate planning and goal setting. An understanding of the impact of any business decision on ultimate bottom line profit is essential. When a businessman forgets that the goal of a business is to make a profit and does not recognize the importance of computing business profitability, he is heading for serious trouble.