7 Layers of Business Profit

7 layers of business profit

Everyone has different definitions of success but we can all agree that for a small business to thrive, it needs to make profit. When you consistently earn profit, you can expand operations, attract funding from investors, and hire more staff which can lead to achieving your business goals.

It can be difficult to do this if you don’t understand the overall process involved in making business profit. As a small business coach I see time and time again how inexperienced business owners don’t realise that only 10% of the money in their bank account is actually profit as they don’t factor the expenses to be deducted from the total revenue.

Once you understand the process, you can increase your efficiency in making money for your business and see those profits climb. This involves identifying the layers that influence business profit and factoring in your figures so you can address any issues to drive your overall revenue.

Uncovering the profit influencers will lead you to make smarter decisions and your business to remain financially viable. Without profit, it’s difficult for a small business to continue operating in the long run.

Differences between profit and cash flow

Understanding the differences between profit and cashflow will help you assess your business performance and financial status more accurately.

These two financial metrics are often confused with terms like revenue, which is actually the gross income your business receives from its operations and other activities.

On the other hand, cash flow refers to the net balance of cash moving in and out of your business in a specified time period. You can have a positive cash flow (i.e. more money is moving in your business) or a negative cash flow (i.e. more money is moving out of your business).

Profit is the amount of money that’s left once your expenses have been subtracted from your total revenue. Similarly to cash flow, profit can show as positive and negative. When your profit calculations total to a negative number, then you’ve incurred a loss.

There are three types of profit:

  • Gross profit. Total profit after the costs of making and selling products or services have been deducted from the revenue
  • Operating profit. Total earnings from your core operations, excluding taxes and interest payments
  • Net profit. Net income after all expenses have been deducted from your revenue, including taxes and interest payments

Once you understand how profit (and loss) works in your business, you’ll find it much easier to identify how it affects different areas of your business.

7 business profit layers you should know about

There are seven layers of business profit that influence the amount of money you can earn. By understanding how they work, you can make more money efficiently and continue growing your business.

1. Traffic to your business

One of the most important goals of online marketing is to drive website traffic to your small business. More people interacting with your brand increases the opportunity for conversions and, by extension, increases your sales.

There are four main types of traffic:

  • Paid traffic. Paid promotions that lead visitors to your website after clicking on an advert you’ve placed on a platform (e.g. Google, Facebook, etc.).
  • Organic search results. Using relevant keywords and focusing on improving your SEO can lead to an increase in your ranking on search engines, allowing more people to find your business online.
  • Referral. Consistently providing high-quality content increases your chances of being referenced by others through their own blogs, resulting in more visitors to your website.
  • Social media. This includes organic audience engagement you receive on your social media platforms such as likes, shares, comments, and views.

Using a strong online marketing strategy including keywords, indexable content, and consistent quality content will ensure you get targeted traffic as opposed to random visitors that don’t meet your customer profile. Once you consistently receive traffic, you can expect higher conversion rates that lead to a bigger customer base.

2. Opt-in lists

Small businesses with online platforms have more ways of engaging with their audience, from actual customers to potential ones. One effective way to reach your audience online is with an opt-in list.

An opt-in list is a database of email addresses of customers who have expressed interest in receiving additional information about your business offerings. Some of the communications you can send to your subscriber list include:

  • Official e-Newsletters
  • Promotional offers
  • New product or service announcements
  • Upcoming brand events or activities

By building your opt-in list, you are able to nurture a relevant customer base that’s already interested in your products, services, or content. This also results in a higher conversion rate because your prospective customers receive more detailed information about products and services.

Creating targeted content through emails allows you to build trust and loyalty with your audience with minimum costs and investment, as opt-in lists are inexpensive to build and maintain.

3. Sales conversions

Sales conversions refers to prospective customers who take a desired, specific action with your business. This can range from booking an appointment, subscribing to your e-Newsletter, or purchasing a product from your website.

By improving your conversion rates, you can increase your profit.

Better conversion rates demonstrate that you are running a cost-effective small business, as you are able to reach a wider audience without needing to increase your marketing budget.

You can increase your conversion rates by showcasing social proof from customers who’ve enjoyed using products or services from your business. Social proof, such as testimonials and case studies, can convince others that your product or service is reliable.

You can also use tracking apps and plugins to identify which sales and marketing strategies are most effective and which ones need improvement.

4. Average pricing

Setting the price for your products and services is one of the most important decisions you’ll make as it greatly affects how much (or how little) your business grows. Your prices and pricing strategies need to be effective and relevant to your customers for your business to be profitable.

To increase your profitability in terms of pricing, you need to understand the differences among the following:

  • Cost. The amount you spent on producing the product or service
  • Price. The amount you receive from providing the product or service
  • Value. The believed worth of the product or service from the customer’s perspective

All three need to be aligned so that you and your customer equally gain value and satisfaction from providing and using the product or service.

There are many pricing tactics that can give you a competitive advantage while satisfying your customer’s needs. You can implement skimming (i.e. charging at a higher price) if you have unique products and services, or you can use penetration, where you start at a lower price and gradually raise it as you gain a loyal customer base.

You should consider raising your prices if:

  • You have firm control over the marketplace.
  • You’re the cheapest option in the market.
  • You don’t have enough cash to fund your growth.

Keep in mind that raising or lowering your prices can have a huge impact on your business. Increasing prices can increase profitability, but lower the volume of purchases. Lowering prices may increase volume, but is often associated with poorer quality.

Assessing the market can help you evaluate your target customer’s buying considerations, including the price range they’re willing to pay.

5. Average items per transaction

The average items per transaction, or sales-per-customer metric helps business owners identify how well a certain product or service performed by indicating the average dollar amount of each transaction.

Small business owners will be aiming for a high number of units to be purchased by each customer to demonstrate great efficiency, product range, quality and profitability. For small businesses that are dependent on salespeople to generate leads, this formula is able to measure staff productivity.

The best way to increase your items-per-transaction is to develop stronger customer relationships. Engaging potential customers in a genuine way builds rapport, which makes it easier for salespeople to reach and exceed their sales targets. By improving your customer’s experience, you increase the likelihood of them making repeat purchases in your business.

6. Average transaction value

Average transaction value (ATV) refers to the average amount a consumer spends with your business in a single transaction. To calculate this, take the total of each of your transactions from a designated time frame (e.g. day, week, month, quarter, etc.) and then divide it by the total number of transactions your business had in the same time frame.

One mistake that small business owners frequently make is to misalign cost periods and ATV periods. You’ll  need to consider the costs involved in the transaction process and whether utilising cut-off periods might mean you miss significant costs (i.e. when a transaction falls into the following time period).

This helps you identify how profitable your business is and what product strategies you can  implement to further increase your ATV. It also helps you assess your current pricing strategies, particularly if you decide to hold a promotion or discount over a specific time period.

7. Profit margins

Monitoring your profit margins will help you evaluate your business financial performance. Typically profit margins are calculated in percentage, which we’ll show in the categories below.

Your profit margin shows how much revenue you receive and how much return on investment (ROI) you get. When you have a low profit margin, this means that you’re not achieving the best ROI for the expenses of your business.

Profit margins have three categories:

  • Gross profit margin. The overall gross revenue minus the cost of goods, then multiplied by 100
  • Operating profit margin. Your operating income divided by revenue, then multiplied by 100
  • Net profit margin. The net income divided by revenue, then multiplied by 100

If your gross profit and operating profit margins are healthy but your net profit margin indicates issues you’ll need to cut nonessential costs to see profits increase.

If the problem is your operating profit margin then you’ll need to look at either reducing your operating costs or increasing the asking price for products and services.

The layers of profit are interconnected and influenced by different areas of your business. Being able to identify and understand these elements can increase your profitability and help better manage your overall profits.

If you need more assistance in building a profitable business, book a call with us.