Home Business Financial Management: Profitability Measures
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Home Business Financial Management: Profitability Measures

Making money is what being in business is all about. Fortunately, there are several measures you can apply to help you determine the profitability of your home-based business once you are under way. These measures are: asset earning power, return on owner's equity, net profit on sales, investment turnover, and return on investment (ROI).
                               business profitability measures

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Making money is what being in business is all about. Fortunately, there are several measures you can apply to help you determine the profitability of your home-based business once you are under way. These measures are: asset earning power, return on owner's equity, net profit on sales, investment turnover, and return on investment (ROI).

Asset Earning Power

This is a ratio calculated by taking your earnings before taxes and interest and dividing that number by your total assets. It is a measure designed to illustrate the earning power of your total assets, not just your liquid assets. For instance, total earnings (before taxes and interest) of $100,000 and total assets of $300,000 would generate an asset earning power of .33, or 33%. This shows you that your total assets are earning you 33% of their present marketable value.

Return on Owner's Equity

The ratio measures the return, or profit, you yield from the amount of equity you've invested in your home-based business. Equity in a company is usually based on capital investment, which incorporates both initial and ongoing capitalization. You can also include any intangible assets such as patents or trade secrets that have been contributed to the business in exchange for equity. If you are the only investor in your company, you control the total equity.

To compute the return on owner's equity, you first have to calculate your average equity investment in the business over a 12-month period. You can find this number on your balance sheet. Divide your net profit by the average equity to arrive at your return on owner's equity. If, for example, you run a personalized children's book business from home and have an average annual investment in the business of $10,000 and your net profit is $6,000, your return on owner's equity would be .60 or 60%.

Net Profit on Sales

This measures the difference between your net sales and what you spend to operate your business. To determine the net profit on sales, you have to divide the net profit by the net sales. The net profit of $6,000 from the above example measured against net sales of $36,000 would give you a net profit on sales of .17 or 17%.

Investment Turnover

Like inventory turnover, investment turnover is used to determine the amount of times per year that your total investment (or assets) revolves. To calculate your investment turnover, divide your total assets are $30,000, your investment turnover would be 1.6.

Return on Investment (ROI)

This determines the performance of a business based on its profitability. There are several ways to determine ROI, but the simplest is to divide the net profit by total assets. If your annual net profit was $10,000 and total assets were $30,000, your ROI would be .33 or 33%.

You can use ROI in several different ways to measure your business' profitability. For instance, you can use ROI to measure the performance of pricing policies, inventory investment, capital equipment investment, and so forth. Some other ways to use ROI within your company are:

  • Dividing net income, interest and taxes by total liabilities to measure rate of earnings of total capital employed
  • Dividing net income and income taxes by proprietary equity and fixed liabilities to produce a rate of earnings on invested capital
  • Dividing net income by total capital plus reserves to calculate the rate of earnings on proprietary equity and stock equity

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