One Business, Multiple Directions: Which One Is Really Profitable?
Over time, many companies begin operating in several business directions simultaneously. A trading company may sell both wholesale and retail, a service company may work with clients from different industries, while a manufacturer may have several product lines.
From the outside, all these directions may appear successful: revenue is growing, the number of customers is increasing, and employees are constantly busy. However, the company’s overall figures often hide the answer to a critical question: which business direction is actually generating profit, and which one is merely consuming employees’ time, tying up working capital, and making the business more difficult to manage?
Total Profit Does Not Show the Full Picture
Financial statements normally show the company’s total revenue, expenses, and profit. However, when a business operates in several directions, the combined result can be misleading.
One direction may generate most of the company’s profit, while another may operate close to break-even or even at a loss. Until the figures are separated by business direction, the owner may incorrectly assume that all services, products, or departments are profitable.
For example, a company may have three directions. The first generates most of the profit, the second operates with a minimal margin, and the third continuously loses money. The company’s total result may still remain positive, but in reality, the first direction is financing the entire business and covering the problems created by the other two.
Revenue Must Be Recorded Separately for Each Direction
The first step is to record the revenue of each direction separately. This can be done by product category, type of service, project, branch, customer group, or sales channel.
The most appropriate structure is the one that reflects how management actually makes decisions.
For example, if a company provides accounting, legal, and consulting services, it should be possible to identify the revenue generated by each type of service. If sales are made through a physical store, an online shop, and business partners, the results of each sales channel should be evaluated separately.
Professional accounting services in Armenia can assist not only with tax accounting and statutory reporting but also with creating a management accounting structure that provides business owners with useful financial information.
Direct Costs Must Be Assigned to the Relevant Product or Service
Separating revenue alone is not enough. Each direction must also be assigned the expenses directly related to its activity.
For a product-based business, direct expenses may include the purchase price, transportation costs, customs duties, packaging, and production materials. For a service-based business, they may include employee time spent on a particular project, subcontractor fees, software costs, and other expenses required to serve the customer.
Many companies consider only the most obvious costs. For example, the salary of an employee working on a consulting project may not be allocated between projects. As a result, the project appears more profitable than it actually is.
If an employee works for three different business directions during the month, their working time and employment cost should be allocated among those directions as accurately as possible.
How Should General Expenses Be Allocated?
Office rent, the director’s salary, marketing expenses, accounting costs, and other administrative expenses usually do not relate exclusively to one business direction. However, they should still be allocated. Otherwise, the profitability of the individual directions will be distorted.
The allocation method should be reasonable and consistent.
Office rent may be divided according to the area used by each department or the number of employees. Marketing costs may be allocated according to the advertising budget spent on each direction. Administrative expenses may be divided based on revenue, employee working hours, or the number of transactions.
The key requirement is consistency. The selected allocation method should not be changed simply to produce a more favourable result for a particular direction.
Margin Is More Important Than Turnover
When comparing business directions, management should consider not only revenue but also gross profit, operating profit, and profit margin.
A direction with high turnover may have a very low margin, require significant inventory, offer customers long payment periods, and consume a large amount of company resources. A smaller direction may be more stable and considerably more profitable.
For example, wholesale sales may generate most of the company’s turnover but have a relatively low margin. At the same time, a smaller retail direction may generate a substantially higher margin.
Without such a comparison, management may continue investing in the direction with the highest sales volume rather than the one that creates the greatest economic value.
Profit Must Be Compared with the Resources Used
Two business directions may generate the same amount of profit while using very different levels of resources.
One direction may require ten employees, a large warehouse, continuous negotiations, and significant working capital. Another may require only two employees and minimal additional investment.
For this reason, management should evaluate not only the total monetary profit but also the result generated per employee, per working hour, or per unit of invested capital.
This is especially important for service businesses. It is useful to track the number of hours spent on each customer or project. Sometimes a customer paying a high monthly fee may, in reality, generate very little profit because they require numerous meetings, frequent corrections, urgent requests, and the constant involvement of senior management.
Accounts Receivable Must Also Be Considered
A direction that appears profitable on paper may still create a cash shortage if customers pay after 60 or 90 days. Customers in another direction may pay in advance.
In this situation, the same accounting profit does not have the same financial value.
For each direction, management should therefore analyse accounts receivable, inventory turnover, customer advances, and cash flow. If a direction constantly requires additional financing, its real efficiency may be significantly lower than the profit and loss report suggests.
Regular Reporting Is More Useful Than an Annual Review
The profitability of individual directions should ideally be assessed monthly or quarterly.
A management report may include:
- - revenue;
- - direct costs;
- - gross profit;
- - allocated general expenses;
- - operating profit;
- - profit margin;
- - key cash flow indicators.
This analysis can initially be prepared in an Excel spreadsheet. However, as the business grows, it becomes more effective to introduce the appropriate analytical categories into the company’s accounting or management reporting system.
Experienced accounting companies in Armenia can help design a structure that is suitable for financial accounting, tax reporting, and management decision-making at the same time.
What Should Be Done After the Analysis?
If a particular direction is generating a loss, this does not necessarily mean that it must be closed immediately. The first step is to understand the reason.
The price may be too low. Costs may not be properly controlled. The number of customers may be insufficient. The direction may also be new and still in the development stage.
Some directions may have strategic value even when they are not directly profitable. They may attract new customers, strengthen the company’s market position, or support the sale of the main product.
However, such decisions should be based on figures rather than assumptions. If management decides to maintain a loss-making direction for strategic reasons, it should know exactly how much that decision costs and how long the company is prepared to finance it.
Conclusion
For a business operating in several directions, total profit is not enough to evaluate performance.
The company must separately calculate the revenue, direct and general expenses, profitability, resources used, and cash flows of each direction. Only then can the owner understand which area should be developed, where prices should be revised, where costs should be reduced, and which direction may need to be discontinued.
A proper analysis often demonstrates that the direction with the highest turnover is not necessarily the most profitable one. The real strength of the business may be found in a smaller segment that generates stable profit and healthy cash flow.
