Logic Profitability

Question

Dear all,

Even though it clearly states that a decrease in profits is due to either lower revenues, higher costs or both, I struggle to apply this logic. More precisely, once the situation changes i.e. increase in profits, flat profits etc. I tend to struggle a lot. How can I improve this?
Somehow I run into a dead end with thinking about "if scenarios of profitability cases (e.g. profits down, revenues etc." The more I think about it, the more confusing it becomes. I know there must be a simple yet powerful logic behind it all...

Can someone explain for example why stagnating profits imply that revenues have been flat, or costs increased or both? Imho profits chan be stagnating also when revenue and costs decrease by the same amount.

Also I have problems when to look at profit margins and when to know the problem can be solved without looking at profit margins.

Help is very welcome! I hope someone understands what I mean with the whole problem above.

Thanks a lot.

Answer 1

You may be getting confused on the difference between profit ($) and profitability (%).

If profits are stagnant then either a) revenue and costs haven't changed or b) revenues and costs changed by the same amount (e.g. $100 rev, $80 cost, $20 profit can change to $150 revenue, $130 cost, $20 profit). BUT, in that case profitability changed from $20/100 = 20% to $20/150 = 13.3%. So you're right, profits can be stagnating when revenue and costs decrease by the same amount, and that is something that you would want to test for.

If profitability is stagnant then revenues and costs must have increased by the same proportion (e.g. using the example above, going to $150 rev, $120 costs, $30 profit). The profit is higher but the level of profitability is the same, still 20%. It can be confusing because sometimes people say profit margin and you don't know what they are referring to, so in a case setting you should definitely clarify if they mean $ or %.