Profitability Is the Right Indicator to Measure Companies

 

The measurement of business success is undoubtedly one of the topics that most interests employers and administrators, as through this you can determine whether the company is on track or not. What is the correct way to measure the financial success of companies?

Many companies have chosen to have “sales” as a reference for success and growth , since there is no doubt that there is no entrepreneur who does not know how much his sales went up last year and even last month , it is a fact that is always updated and present since it has become the main indicator on which the strategies and recognitions are based ; however, this data is not accurate regarding success .

If we had to define what sales are in a simple way, we could say that they are the number of products and / or services that companies have marketed in a certain period, but is this good or bad? , the answer we do not know, since the data seem insufficient. Imagine that a company sells $ 1’000 mm; However, it has expenditures of $ 1’300 mm. Did the company do well? The reality is that it had a loss of 30% with respect to its sales.

On the other hand, a few other entrepreneurs are not only interested in sales, but in another indicator that gives them more information about the success of their company, “the utility” , since they are clear that selling a lot without earning, it is not business , so when the results are analyzed, companies can be heard talking about profits of millions of pesos, which makes owners and employees happy, since this data, unlike sales, is more palpable .

However, if we analyze in a more precise way the meaning of the utility we can define it as the residual amount that the companies have to carry out the commercialization of their products and / or services and pay the costs, expenses and taxes, so we must ask Is a company good because it earns a lot? , the answer is difficult to answer because we need data again. Imagine a company that earns $ 1’000 mm, but in order to earn this amount it had to make sales for $ 100’000 mm, that is, its profits represent only 1% of its sales, so now we ask ourselves, for whom is it working the company ?, for the employees ?, for the bank? or for the treasury ?, for whom?

The above, makes us understand that winning a lot is not a sign that a company is successful , so now we must talk about the true concept that measures success to companies: “profitability.” We can define it as the justification that a business is a business, or in other words that what the entrepreneur earns justifies the risk that this runs when putting a company.

The above definition makes us realize that not all businesses are businesses, even when they sell and even obtain profits.

In terms of profitability, there are two measurements:

In terms of profitability, there are two measurements:

 

  1. The margin. It is the result of the efficiency in the operation of the company that depends on the optimization , unlike the utility that is not another thing that the remainder of the sales after covering the costs, the expenses, the taxes.
    Measures the proportion in relative terms of the utility against the sale that gave rise to it, the margin can increase or decrease depending on the percentages of costs or expenses, so it is important to be clear that promotions and discounts have a direct impact on the margin of the company and therefore in the profitability.
  2. The ROE, known by its acronym (Return of Equity), ie return on capital or profitability of shareholders , refers to the rate they receive on their invested capital, which must be attractive, sufficient and reward risk .

It is important to note that the investment of the shareholders and the bank debts are a source of financing; however, the banks carry out a strenuous evaluation to define the rate they will charge, in addition to demanding guarantees and collecting interest regardless of the result the company has.

On the other hand, shareholders invest without guarantees and only see profits (returns) if there are profits , that is, their capital is more risky than banks when financing the company, for this reason, shareholders should consider as a source of comparison the bank rate, but to which banks charge not to which they pay.

In conclusion, companies are not good because they sell a lot, not because they earn a lot, but because they are profitable .

 

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