Profit is what being in business is all about. It’s what we all work so hard to improve and to grow. Congratulating clients on the great profit they’ve made so far this year is a highly enjoyable part of what I do.
Invariably though, the next question is: “So, where is it?”
Most business owners understand what the Profit & Loss Statement is and what it shows (albeit to different degrees). Essentially, the profit figure on your P&L is the end result of revenue less expenses. It shows how much revenue has come in, what expenses are required to run the business and how sufficiently revenue has covered the expenses.
On the other hand, not so many business owners know what the Balance Sheet is all about nor the essential information that it can tell you. The Balance Sheet holds a lot of answers about the health of the business and it also shows where the profit has disappeared to.
2 of the usual suspects…
Profit often gets “caught” in a business in a number of ways (good & bad). Here’s the common 2 culprits of tying up profit in a business:
Debtors: The business may be making great sales, revenue is growing and things look good on the P&L. If the Debtor balance grows relative to the growth of sales, than in most cases the cashflow of the business will track along fine. However, perhaps insufficient Debtor Management practices are in place and customers are taking too long to pay forcing the Debtors balance to increase significantly in proportion to sales growth. Slow paying customers and poor Debtor management unnecessarily ties up cash. It’s imperative for good business that invoicing is done both correctly and timely and that a system is in place to routinely follow up customer payments.
Stock: Businesses with stock need to have sufficient practices in place to ensure cash/profit isn’t excessively tied up in stock on hand. If your stock purchaser is buying overs, or buying the wrong type of stock that isn’t selling or stock that isn’t required, then you are unnecessarily tying up cash in stock that could be used for something else.
If you would like to better understand your Balance Sheet and where your profit may be hidden, please get in touch today.
You need to plan to get out of your business, just like you need a plan to get into business.
There are 3 ways to leave your business:
Planning to sell is actually more important in some ways and slightly more complicated than starting up business. It requires foresight, strategising and careful implementation.
Your efforts will help get the best return possible for all of those years of hard work!!!
Here are 5 tips to consider when selling your business:
1) Sell at the right time for the right reasons
In most cases you’ll get the best result selling your business when sales are climbing and profits are strong. If you have a history of solid performance it would be a good idea to consider selling before trouble strikes.
On the other hand, if you’ve been through troubled times but things have turned a corner, you may be best to hold onto the business and get things in order to be able to provide at least 1 -2 years of strong performance history before looking to sell. Remember, prospective buyers will not pay for potential.
External factors which may influence the timing of your sale include availability of financing, changes in tax and other relevant laws, industry changes, the general economic climate and interest rate trends. How are they impacting your business?
2) Decide what you’re selling
Determine what the assets of your business are that have value that someone else is willing to pay for. Selling a business often includes assets such as goodwill, trademarks and client lists/history as well as the physical assets.
If you’re looking to sell to an existing business they may consider your client list to be the most valuable part of the transaction and may not even need to take on your assets. On the other hand, a stand-alone buyer may need to take over everything required to make the business run.
If your business is incorporated, you also need to decide if you are going to sell your business as an asset sale (where you sell everything in the corporation but not the incorporated company itself) or a share sale (where you sell everything including your incorporated company).
3) Determine what your business is actually worth
Buyers are interested in profits, not revenue, and cash flow is usually more important than profits when valuing small businesses.
Consider the business’s ability to sell, its readiness and your timing. There are many attributes that can make your business appear more attractive, including:
- Increasing profits
- Consistent income figures
- A strong customer base
- A major contract that spans several years
There are several different business valuation methods. No one approach can be used in isolation; the current market, economic trends and what other similar businesses have sold for also need to be taken into account.
4) Make sure your house is in order
Prepare your business ahead of time, preferably at least a year or two beforehand. The preparation time will allow you to improve your financial records, business structure and customer base to make your business more profitable and appealing to potential buyers.
Even if you decide not to sell straight away, you will personally reap the benefits and ultimately will increase your future selling price = win/win.
5) Get professional advice
Selling your business arguably could be a bigger event than selling your family home, so do yourself a favour and get professional advice along the way.
Gross profit is a key indicator of your business’s overall health, so keep reading!
Measuring and monitoring your gross profit regularly will tell you a LOT about what’s happening in your business and how you can make more money.
So firstly, what is gross profit?
Gross Profit =
Cost of Goods Sold
It’s usually represented as a % of sales.
Generally, the higher the gross profit % the better.
Gross profit can be measured for your business overall and it can also be used on a more detailed level for eg. per product line, type of customer, location etc.
Why is gross profit so important?
Gross profit is the amount of money left over from sales to cover your overhead expenses (electricity, rent, insurance etc). In most cases your overheads are relatively fixed and there’s not a lot that you can do about them. Not the same for gross profit!
Measuring and monitoring gross profit and investigating significant fluctuations allows you to know exactly where, how and why changes need to be made so that you can make more money from each sale.
It’s imperative to understand what your most profitable and least profitable product/service lines are. You may use the information decide to stop offering unprofitable lines and/or decide to “push” your more profitable lines in your marketing for example.
What should you be looking for?
Gross profit should remain fairly stable over time. If it fluctuates significantly downwards it’s an indicator to further investigate for things such as possible fraud, accounting irregularities, mismanagement or perhaps increased competition. If any of these are the case, it’s obviously best to sort them out ASAP.
If your gross profit fluctuates in a positive way, it could indicate an improved product mix shift, better buying decisions or improved efficiencies. It’s good to know these things so that you can keep doing them!
So it makes a lot of sense to keep your eyes firmly on your gross profit right?
- Determine your overall business gross profit and monitor it regularly (eg monthly)
- Determine the gross profit of your individual product /service lines (and even by location, customer type, business divisions if possible) and monitor regularly.
- Make an effort not to discount or compete on price. Instead, look for ways to differentiate your offering on another basis eg. turnaround time, availability of support, ease to buy etc
- Review your supplier’s invoices regularly to ensure quantities and prices are correct and are reflected in your sales model (know in advance when supplier prices have been pushed up so that you can consider raising your sales price)
- Have strong systems in place for stock/materials. If stock goes missing for example or you have a lot of wastage it will affect your gross profit. If reporting is incorrect it will also impact your gross profit. If stock is obsolete or slow to move, then consider dumping it.
- Measure and monitor!!!
Knowing exactly how your business is performing NOW is arguably one of the biggest keys to improving your business performance in the future.
With the development of cloud accounting, all the information is at your fingertips on a timely basis. You just need to use it!
Case study: Retail shop owner wants to better understand shop sales and usage of employees.
Business owners start to know this kind of information in their head ie how much the shop would generally take on any given day. However, it’s not much use to anyone up there!
Action: With a few changes to the data entry process, this information can easily be gathered, tracked and then reported on using the xero accounting system.
I have recently set up xero to track “daily shop sales” for my client. By also using the timesheet function, we can then start to report the use of employees v the revenue brought into the business on any given day.
Benefits: These changes will enable us to see –
- Which days generally bring in more revenue than others
- Which days typically require more labour
- Which (if any) employees are more productive than others
- How many sales (quantity) were made on a particular day
- What the average sale was on any given day (and any period of time)
Value: The business owner is now better equipped to determine rostering requirements and potentially save money on days where additional labour is not required, or perhaps schedule time for themselves on those quieter days to conduct any training and work ON growing the business.
Ultimately, by tracking the $ value of sales, # of customers in the store and the average value of each sale we can also now track the effectiveness of any sales strategies that are implemented.
Worthwhile exercise don’t you think?!
Take Home: What could you be tracking in your business to help you “join the dots” and move your business forward?
What do you do to keep your finger on the pulse of your business? A quick check of the bank balance perhaps? A walk around the factory floor? Every business owner has their own way(s) of determining how well their business is performing. Successful business owners have a firm grip on how their business is performing and how it should be performing.
As a business owner, it’s always good to get your hands on business benchmarking information for comparison purposes. Finding good benchmark data is easier said than done though! Compiled from tax returns and Business Activity Statements, the ATO has some basic benchmark data available for small business, and it’s worth taking a look.
The ATO benchmarking data is handy for a couple of reasons. As well as providing you with an idea of how your business performs against others in your industry and turnover range, it seems that you will also find out if your business is on an ATO radar. According to the ATO, businesses operating outside their key benchmark range “may be contacted” by the ATO. Useful to know? – yes!
I recently found the ATO small business benchmarks to be a useful guide for a client of mine (as below). I discovered that the business is performing and reporting inside the benchmark ratio zones. So just based on this, the business would not fall on an ATO target list. Additionally, labour levels form part of our regular business monitoring, so it’s also interesting to note that my client’s labour levels are less than the industry average (21% v 27%). And it’s always good to know that motor vehicle expenses are on the lower side of “normal”!
ATO Benchmark Ratio Name
ATO Industry Benchmark Ratio
Client Business Ratio
21% – 32%
|Total Exps/ Turnover||
84% – 93%
|Average Total Exps||
|Non Capital Purchases (BAS)/ Total Sales||
51% – 65%
|Motor Vehicle Exps / Turnover||
I recommend that you develop ways of having a strong, reliable “finger on the pulse” of your business. Why not compare your business’ results against the ATO benchmark ratios and see how your business measures up? I’m more than happy to quickly run the numbers for your business, just ask! A small donation to my fundraising page as a token of appreciation would be greatly appreciated.