The Finance Gem 💎 #91 - The Profit Issue

Welcome to Issue #91 of The Finance Gem

TODAY’S FINANCE GEMS

1. How to Analyze Business Profitability

2. 10 Levels of Profitability

3. The Performance KPI Checklist.

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1. How to Analyze Business Profitability

Most business problems fall into one of 3 main areas:

1. Profitability: How effectively your business generates profit in relation to its expenses

2. Cash Flow: The management of the inflow and outflow of cash, ensuring that your business can meet its financial obligations

3. Growth: The ability of your business to expand in a sustainable and profitable way

Let me show you how to use financial analysis to diagnose and solve the first and most sensitive one of these problems: Profitability.

Gross Profit Margin = (Gross Profit / Revenue) × 100

This is the first signal your core offering may be under pressure.

This measures how efficiently you're converting inputs—raw materials and labor—into value.

If this margin is falling, you're likely facing:

• Rising direct costs (materials, labor, freight)

• Pricing that hasn't kept up with inflation or competitive shifts

How to address: Renegotiate supplier terms, streamline production, cut waste, or reprice strategically.

Operating Profit Margin = (Operating Income / Revenue) × 100

This margin shows how well you’re managing the rest of your cost structure beyond COGS—namely SG&A, admin, and fixed costs.

Sustained drops here usually signal a lack of scalability or cost discipline.

If Operating margin is deteriorating, it means expenses are scaling faster than revenue.

How to address: Evaluate cost-to-serve across functions, automate recurring activities, and rethink resource allocation.

Net Profit Margin = (Net Income / Revenue) × 100

This is your bottom line—what remains after interest, taxes, depreciation, and any non-operating costs.

If only this margin is falling, you likely have inefficiencies in debt servicing (too much leverage or poor terms) OR tax strategy (poor entity structure or missed opportunities)

How to address: Refinance, restructure, or optimize tax positions.

But if net margin drops along with gross and operating, the issue is systemic—your business model, pricing power, or cost structure needs a hard reset.

Margin analysis isn’t academic—it’s how you protect value, unlock cash, and reposition your business for scale. Don’t just look at the number. Look at what it’s trying to tell you.

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2. Ten Levels of Profitability

Every profitability metric tells a story.
The real question is—do you know what it’s trying to say?

Here’s a breakdown of the key metrics you should be tracking—and what each one reveals about the financial engine of your business:

1. Gross Profit:

   • Story: Reflects efficiency in producing the products or services sold, before considering general operating costs.

   • Purpose: To assess the direct profitability of a company’s operations.

2. Operating Profit (EBIT = Earnings Before Interest and Taxes):

   • Story: Provides insight into the management of day-to-day operations, including production, staffing, and overhead.

   • Purpose: To gauge a company's operating efficiency before finance and tax expenses.

3. Net Profit (Net Income):

   • Story: The bottom-line indicator of financial health, reflecting ability to generate profit after all expenses, including taxes and interest.

   • Purpose: To provide a comprehensive view of a company's overall profitability.

4. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):

   • Story: Shows operating profitability before the effects of financing decisions, tax environments, and non-cash accounting items like depreciation and amortization.

   • Purpose: To compare profitability across companies in the same industry space

5. Adjusted EBITDA:

   • Story: Refines the EBITDA calculation by adjusting for one-time, irregular, or non-recurring items

   • Purpose: To assess a company's sustainable and ongoing operational profitability.

6. Segment or Product Line Profitability:

   • Story: Reveals the performance of individual business units or product lines, showing which areas contribute the most to overall profitability.

   • Purpose: To identify strengths and weaknesses within a company's portfolio and therefore guide strategic decisions on resource allocation and product development.

7. Return on Equity (ROE):

   • Story: Demonstrates how effectively a company is using shareholders' equity to generate profits, indicating management’s ability to deliver returns to investors.

   • Purpose: To measure the profitability relative to shareholders' equity, helping investors understand the efficiency of their investment.

8. Return on Assets (ROA):

   • Story: Highlights management effectiveness in using assets to generate earnings

   • Purpose: To assess how well the company converts its asset base into profit.

9. Economic Profit (or Economic Value Added - EVA):

   • Story: Goes beyond traditional accounting measures to assess whether the company is truly creating value over and above its cost of capital.

   • Purpose: To determine if the company is effective at generating value for its shareholders.

10. Operating Cash Flow Profitability:

    • Story: Focuses on the actual cash generated from business operations, cutting through the noise of accounting conventions and non-cash items.

    • Purpose: To evaluate the company's ability to generate cash to support growth funding, debt repayments, and shareholder distributions.

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3. The Performance KPI Checklist.

Profitability sets the goal. Costs define the constraints.

Profitability shows how successful your business is at generating returns. Costs reveal how efficiently you're using resources to get there. And strong performance depends on both.

Still, most businesses focus too heavily on revenue and margins—without managing the cost levers that quietly shape them.

That’s why I built a Performance Checklist with 36 essential KPIs to help you measure, monitor, and manage both profitability and cost efficiency.

Here’s how to think about it:

Profitability Management:

1. Assess your revenue streams to identify the most lucrative ones.

2. Optimize pricing strategies to ensure maximum profit margins.

3. Diversify sources of income to spread risk.

4. Leverage high-performing assets to capitalize on profitable opportunities.

5. Analyze profitability trends to foresee potential future growth areas.

6. Reinvest profits wisely to fuel sustainable growth.

7. Benchmark against industry standards to ensure competitive positioning.

↳ How to select Profitability KPIs:

1. Prioritize KPIs that align with your business's strategic goals.

2. Segment your profitability metrics to address different revenue streams.

3. Simplify your selection to focus on key drivers rather than all possible metrics.

4. Review the selected KPIs regularly to ensure their continued relevance.

Cost Management:

1. Scrutinize all expenditures to identify any wastage or redundancies.

2. Negotiate with suppliers to secure the best prices without compromising on quality.

3. Streamline processes to increase operational efficiency.

4. Monitor overheads closely to avoid unnecessary expenses.

5. Investigate any sudden spikes in costs.

6. Implement cost-saving technologies and practices.

7. Benchmark costs against industry averages to identify areas of improvement.

↳ How to select your Cost KPIs:

1. Highlight KPIs that directly impact your bottom line.

2. Categorize cost metrics into fixed, variable, and semi-variable to target cost-saving initiatives effectively.

3. Prioritize KPIs that offer actionable insights rather than generic information.

4. Re-evaluate and adjust cost KPIs based on changing business conditions and goals.

POLL TIME

As always, if you have specific suggestions or feedback, simply reply to this email.

Thanks so much for reading.

Oana

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