Out of the three important ratios, i.e., Current ratio, TOL / TNW and Profitability, we discuss about Profitability.

To understand Profitability, please see the following table of two companies in a similar industry

Example I

Company A		Company B
Sales	100	Sales	50
Profit	10	Profit	6
Profitability	10 %	Profitability	12 %

 

In terms of absolute number, Company ‘A’ looks attractive. However, the profit/sales %, ‘B’ stands first with lower sales showing a higher percentage of net profit. ‘B’s efficiency is better than ‘A’, when profitability is given weightage. Normally, a good company should work on improving the profitability in the long run. Optimum utilization of available resources and improving sales with the existing capacity would lead higher profitability.

ROCE (Return On Capital Employed)

 

Profit before depreciation + interest + tax ROCE =   ----------------------------------------------------                               Total capital invested

Example II

Company A		Company B
Net Profit	100	Net Profit	100
Depreciation	20	Depreciation	20
Interest	40	Interest	20
Tax	20	Tax	10
Capital Employed	1000	Capital Employed	1000
ROCE	180 ------  x 100   = 18% 1000	ROCE	150 ------  x 100   = 15% 1000

In this ratio, Company A is performing well since this ratio analyzes mainly operating efficiency of the company by adding back depreciation, interest and tax. A Company with a higher ROCE will be positively viewed by the investors / bankers.

 

Seven ways of improving profitability

1. Overall Cost Management.
2. Purchase of raw materials at discount.
3. Optimization of work force.
4. Reduction of workspace / rent payable / etc.,
5. Finding ways to sell at a higher price in a newer market.
6. Outsourcing model.
7. Technology support.

1. Overall Cost Management

Cost of production to sales plays a vital role in a business environment. Since the price of end product becomes non-negotiable and already discounted by other well established players the market will not accept a premium for a new product. The only way shall be to reduce the cost. Towards that aim, a company has to work on cost cutting on various inputs.

For e.g. a company studied the cost of packing and found that the gunny bags were stitched with nylon thread. The workers were leaving few inches on both sides of the gunny bags after stitching. The company requested the workers to trim it exactly at the edge of the gunny bags and found a huge cost reduction in purchase of nylon thread, by optimizing the usage.

2. Purchase of raw materials at discount

During seasonal time the raw material (say cotton) is available at a discount. The business owner should plan to adequately stock the resource and plan with a financing solution well ahead.

Sometime import shall be cheaper than domestic supply. The business owner should be able to switch over to such opportunities. Using adequate working capital, one can buy the product at a discount. While going for higher market credit the cost of raw materials will be higher.

3. Optimization of work force

Of late, there are older organizations which keep redundant work forces for want of emotional connect. While due respect to be given for their support to develop the organization from scratch it is prudent to empower them with outsourced model or use their expertise to promote other vertical, open branches in other location.

4. Reduction of workspace / rent payable /  etc

Sometime huge land bank is kept without any production capability. The management is operating within a city paying huge rent. It is time to go to outskirts or to lesser cost location in order to reduce the cost. The polluting industry is an example where they had set up factory like foundry within city long back. Shifting to new location with cheap land cost could be considered for cost reduction. 

5. Finding ways to sell at a higher price in a newer market

One of the best ways is to explore continuously. The market is wide open with the advent of e-commerce. One can sell in new market at a higher price without intermediary support.

6. Outsourcing model

When experts are available on outsourced model it is perfect to avail their service instead of keeping a high paid executives to carry out that job for a full term. Investing on machinery may be costly if the work is not of continuous nature. It is therefore, preferable to get the work through outsourced model. Best example of the same is hosiery garments units at Tirupur. They use dying unit and compacting units for job work because these type of industries are highly capital intensive.

7.  Technology support

The time is fast changing to adapt to new Technologies. The quicker to adopt, it is better for the company to reduce cost of various productions by introducing technology.