Main Factors Affecting Business Profits
The success of any entity depends on its ability to earn profits continuously. Making profits may not be the core goal of starting and running your business. However, it is essential to grow from a startup or small business to a fully established and self-sufficient entity. By making profits, you’ll get to pay yourself as the owner. You’ll also get to fund expansion, attract investors and persuade lenders such as banks to issue you a business loan.
What Factors Affect Business Profitability?
A business earns a profit when it makes revenue that exceeds the costs, expenses, and taxes incurred. It can either retain the profits to grow and expand the business or issue them as dividends to the owners.
This post will highlight factors affecting business profits. Some are internal, meaning you can control them. Others are external, which means they are not within your locus of control. We will also tackle a couple of frequently asked questions to give you all you need to know about business profits.
Factors Within Your Control
We will start with the internal factors that help determine your profit. These are the factors that you can control.
Direct costs are those directly involved in producing a good or rendering a service. Three classic examples of these costs are ingredients and materials, logistics, and labor expenses.
Direct costs are the ones you incur when producing your goods or services. The amount of money you use on direct costs determines the profits you can make. An increase in direct costs results in a reduction in profits, while a decline causes a rise.
Operating costs are the costs associated with the daily transactions and activities of the business. You can’t directly trace them back to production, but they are necessary. Examples of this cost are rent and the electricity bill.
Like direct costs, a high operating cost can reduce your net profits. Strive to keep your operating costs as low as possible to help you maximize your net profits.
Another factor that directly affects your profitability is your pricing. Lowering the price of your products reduces your profit margin and, in turn, profitability per unit. Increasing, by contrast, enables you to be more profitable, assuming the demand for your products remains constant.
Low prices can also increase your product’s demand, thus increasing your profitability and vice versa. It depends on your target customers and the factors affecting the customer’s demand for your goods or services. For example, if you target high-end customers, increasing prices will most likely not deter them from purchasing your products.
Marketing and Advertising
Marketing and advertising your products increases demand. It gets more customers to buy from you, which increases your sales revenue. Once you deduct costs, expenses, and taxes from your sales revenue, you remain with higher profits. However, you need to ensure your advertising cost is not so high that it exceeds your profits or sales revenue.
Economies of Scale
Economies of scale are the cost benefits of producing products or rendering services in bulk. For example, assume you want to transport bags of sugar. You’ll save more per bag if your transport 1,000 bags versus 100. You’ll still need only one driver. You might have to get a larger truck, but the fuel cost will not change much. Economies of scale reduce your cost per unit produced, enabling you to make more profits.
The way you manage your business also determines your profitability. Good management leads to more profits for your business. Poor management, by contrast, may hurt your sales and productivity, which negatively affects your profitability.
Good management leads to an increase in employee morale and productivity. It may also lead to better planning, budgeting, and forecasting. For example, a company that empowers its customer care agents enables better customer service. Empowering them increases customer retention, which leads to more sales for the business.
Your business core objectives can also determine the profits you make. Not all businesses focus on making profits. Some seek to expand first or increase market share before turning to profitability. In this case, the revenue may be geared to focus on advertising to obtain more market share or opening new stores and branches to expand the business.
Factors Out of Your Control
While you can control internal factors that determine your business’s profitability, there are external ones that you can’t control. Let’s explore them in detail.
If your business relies on imported supplies, a rise in exchange rates will reduce your profitability. A drop, by contrast, will make you more profitable.
A price cap occurs when the government limits the prices a business or service provider can charge. This regulation applies to specific industries and businesses, such as those providing a public utility. A price cap may hurt your profit margin. If you are affected, you may have to find alternative ways to reduce costs.
Inflation leads to a decline in the consumer’s purchasing power. Customers won’t buy as many goods and services as they used to, which hurts the sales revenue of most businesses. A reduction in sales revenue leads to a decline in profits.
If the government decides to increase taxation, your business will profit less from its sales. You will have to use more of your revenue to cover the taxes payable.
Competition reduces an entity’s profitability. It provides the customer with more options and affects how a business prices its products and services. If your product is high-priced, many customers will opt to buy from your competitors.
State of Economy
When the economy is booming, people tend to spend more, especially on luxury products and services. Businesses make more sales since there is more money in circulation. Contrastingly, customers use less money when there is a recession.
Frequently Asked Questions (FAQs)
Let’s look at a few frequently asked questions to help you better understand business profitability.
1. What might cause profits to fall?
The two reasons profits drop are either a decline in sales revenue or an increase in expenses, costs, and taxes.
When revenue declines, it means you won’t have enough funds to cover all your costs and expenses. Your sales revenue can decrease when you sell fewer goods or services or lower your prices. Using the same logic, when your costs increase, more money is going out of your business than coming in.
2. What factors affect the profit margin of a product?
The profit margin of a product or service is also known as the gross profit margin. Gross profit is the difference between the sales revenue and the cost of goods sold (COGS), i.e., cost directly related to producing a good or service. To calculate gross profit margin, divide gross profit with sales revenue, then multiply by 100.
The two factors that affect gross profit margin are changes in sales revenue and cost of goods sold. As mentioned above, sales revenue can change when you lower or increase the prices of your goods. COGS changes when your production cost changes, for example, when one of your suppliers increases its prices.
3. Is it better to have a higher or lower net profit margin?
It’s better to have a higher net profit margin. A higher net margin means you will make more profit from your sales.
4. Does factor cost include profit to the producer?
No, factor cost does not include a profit margin. Factor cost refers to the total cost of all factors of production used in the making of a good or service. It is the actual cost a business incurs when producing a good or service.
The factors of production include land, labor, capital, and entrepreneurship. Factor cost does not include profits generated by the producing firm or taxes incurred in making the good or service.
5. Is profit margin everything in business?
Having a good profit margin is essential, but it is not everything in business. A business can exist for different goals or purposes. Their existence may be geared to solving a world problem, offering a good or service, or adding value to people’s lives. As a business, you don’t have to focus solely on the profit margin.
6. What businesses have high long-term profit margins?
Businesses that have high profitability are those that operate in an environment with less competition and where the barriers to entry are high. Companies like Google, Microsoft, and Coca-Cola conduct business as duopolies and oligopolies, thus making more from their sales.
7. How can low-margin businesses be successful?
A low-margin means you’ll be making fewer profits from each sale. It will, however, allow you to sell more goods and services to many customers, especially if your prices are below the market price. The profit margin may be low. Regardless, since you are selling to many people, you can still make a good profit and be successful.
Earning a profit is, in most cases, not the core objective of being in business. It is, however, essential if you want to grow your company and make some income from it. An entity makes a profit when the sales revenue surpasses the expenses, costs, and taxes payable.
The internal factors that determine business profitability include direct and operating costs, pricing, economies of scale, and management. Your business goals and objectives may also affect how much profit you can make.
The external factors that affect profitability are inflation, state of the economy, price caps, and exchange rates. Taxation rates, the occurrence of pandemics, and competition are also part of the external factors.
Below you’ll find a few resources that can come in handy and help you explore more information. In addition, many of the resources lead to links to recent and popular publications. So if you’re interested, take some time to browse.
The Factors Affecting Profit
In this section, you’ll find information leading to the factors that affect profit. Even though this article contains a lot of information, it doesn’t hurt to see what New publications are published and ready to discover. Since it’s a Google search result, you’ll find the most popular and relevant topics. You’ll also find in the results topics related to the subject. So, have a look at the latest search results for business profitability.
Books are another great source of information for virtually any topic. Some of the books listed online offer a preview, or you can check out the table of contents to see what the book has to offer and if it’s something you’re looking for.
The media’s stories about company profits can provide insights into business profits. In addition, you’ll get the latest and archives new stories related to the topic from the link below.
Videos are an excellent source of information for those that are visual learners. Many videos that are popular on YouTube are a few minutes long. That being said, you can go through many videos in an hour that will give you an overview of ways to improve profitability in a business. See the most recent videos related to improving profits.