To have profitability you need to know where you are starting with profitability. That means calculating your net profit per hour.
How many times have you gone to a meeting where business owners were bragging about their sales? “I’m up 20% over last year,” could be a typical comment. But did anyone ask them about their profit increase from year to year? Public companies have to report their sales and profits. Small business owners don’t. So profit figures are kept secret. Probably because most of them are dismal.
Reality: Sales matter. Profits matter most. One of my favorite lines: Volume is vanity. Profits are Sanity. If you don’t know what your company is earning for each hour that you produce products and services, then you’re clueless about profitability, the thing that matters most to sustaining your business for the long term.
So, how do you really see how profitable you are? By calculating your net profit per hour. Here’s how to do it:
Net profit per hour = net operating profit / total revenue producing or billable hours
Many times it’s a “slap in the face” when you calculate this number for the first time. We calculated it in a Courage to be Profitable class last week, and the highest net profit per hour was $3.60. The lowest was less than $1. At least they were positive. (A negative net profit per hour means that you are paying your customers to provide products and services to them).
A few months ago, half the business people in the room said they were afraid to calculate this number. I know what their businesses are like if they are afraid of calculating net profit per hour.
When you calculate this number, you really see what you are taking home. You’re not looking at sales. You’re not looking at gross profit. You’re including all of your business expenses, including overhead, to see the true bottom line. You’re not fooling yourself with gross profit per man day or any other calculation based on gross profit.
Here are the four most frequent questions that I get about calculating net profit per hour:
Question #1: Why should I look at my profits this way?
You should be looking at your bottom line; it’s the most important part of your business. The top line is important. The gross profit line is important. But the most important line is your bottom line profit. What are you making each hour that an employee works to produce your products and services? Start managing your business from the bottom up, and you will soon experience more profit and more profitable sales.
Question #2: What should my net profit per hour be?
The answer to this one is long, too. I really don’t care about key performance indicators (KPI’s) because they give you a false sense of security. If you’re above KPI for net profit per hour you relax and may not pay as much attention to your bottom line as you should.
The most important thing is the trend: is your net profit per hour increasing? Even if you are below the net profit per hour KPI, as long as it is increasing, you are headed in the right direction. If you are above the KPI but your net profit per hour is decreasing, then you are headed the wrong way and should take action to correct the downward trend.
Question #3: When should I calculate my net profit per hour?
Annually is best. When you look at an annual number, you are taking out the year’s seasonality. Busy and slow months do affect net profit per hour calculations when you calculate the ratio monthly.
Since it is October, for those of you with a December fiscal year end, calculating the net profit per hour for these 10 months probably is ok. The likelihood of it changing dramatically over the next two months is slim. However, calculate your net profit per hour for fiscal 2012 and compare it to year to date 2013.
Question #4: What hours should I include in the calculation?
Only include billable or revenue producing hours. For example, you may pay your field employees for 2080 hours per year. However, some of those hours are vacation, holiday, sick time, meeting time, and training time. Only include those hours that your employees actually worked producing revenue for your company.
Start thinking bottom line rather than gross profit line or sales. Managing your business by net profit per hour will truly help you generate more profitable sales.
I challenge you to calculate your company’s net profit per hour. What is it? Are you comfortable with it? Are you shocked by it?
If your net profit per hour is not enough, from your perspective, then change it. What will it take to get to the level that makes you comfortable?
If you are comfortable with your net profit per hour. Congratulations. Just keep it there or grow it even further.