Real, lasting improvements to profitability can be difficult to implement, in part because too many executives aren't focused on the most important drivers of profitability, according to Al Bates, director of research for Profit Planning Group and principal of the Distribution Performance Project, in Chasing Profitability.
Growing sales, for example, is important, but only because of inflation. What is needed is enough growth to allow the firm to offset the impact of inflation on expenses with some relative ease.
The best measure of financial performance – and profitability – is actually return on assets. ROA is usually a pretty stable measure, but even small changes tend to produce a large cumulative impact over time. Higher profit provides greater funds for reinvestment in growing the business.
Management must utilize critical profit variables, such as gross margin or inventory turnover, to produce the highest possible ROA within the constraints of the industry. But they should also make sure they're reading the results correctly. What may look positive on the surface may actually be a decline when assessed in conjunction with the other variables.
Read more about how to achieve and measure profitability in Chasing Profitability.
