Quick Profit Assessment: Profitability Gap

Have you ever wondered if your business is as profitable as it could be?

It’s hard to know when you only have your historical financial reports to compare to.

The quickest way to answer the question is to calculate the profitability gap.

What is a Profitability Gap?

A profitability gap is the difference between your current profit level versus what your profit could be.

Why is it important to identify the Profitability Gap?

It is fun to watch our sales increase, but it is painful when cash is tight and we struggle to pay our bills. Even though you may be profitable, your business may not be profitable enough.

It’s important to implement systems in your business that increase sales, profit and cashflow at the same rate.

The profitability gap will give you a clearly defined goal.

Profitability Gap Formula

Net Profit Goal - Actual Net Profit = Profitability Gap

What is my Net Profit Goal?

Your net profit goal is a number you choose or you can rely on industry standards. Depending on the industry, a good margin will vary. The following chart is a good general overview to help you get started, if you do not have industry specific data.

How to calculate the Profitability Gap

Step 1: Identify your Net Profit Goal

Multiply your sales $1,000,000 x Net Profit Margin Goal 10% = Net Profit Goal $100,000

Step 2: Note your actual Net Profit

Actual Net Profit (Profit and Loss Statement - bottom line) = $30,000

Step 3: Calculate the Profitability Gap

Net Profit Goal $100,000 - Actual Net Profit $30,000 = Profitability Gap $70,000

How to eliminate the Profitability Gap

Consider increasing your prices
Review profitability by department, service, customer, project or employee
Charge for change orders
Reduce mistakes
Limit discounts

Bottom Line

Business is complicated. Calculating the profitability gap reduces the chaos. One simple number will give you the focus you need to research where your profit leaks are hiding. What could you do with an extra $70,000 in your business?