As a small business owner you are great at what you do whether it’s marketing, coaching, designing or running a restaurant – yo’ve got it nailed. What you may not be so comfortable with is knowing how to monitor your financials in your business and knowing what reports to run and what numbers to check. Sometimes it’s just way too much and it’s easier to stick in your comfort zone and do the things you know … hoping that the rest will take care of itself. Besides you’ve got money coming into the bank so it should be fine right?
To help support your business and give you the confidence to KNOW the numbers here’s a quick rundown of the big picture, the numbers that matter and how to know if you are turning a profit.
#1 Check Net Profit Margin
Net profit is a key number to determine your company’s profitability. Use this simple formula to calculate net profit:
Revenue – Expenses = Profit
A positive number means you’re turning a profit. If it’s a negative number, your business is losing money. Zero means you’re breaking even.
For example, a business with revenue of £75,000 per year and £15,000 in expenses has a net annual profit of £60,000.
Accounting software makes this process very simple as it automatically generates a profit and loss statement for your business.
It’s important to not only look at profits on an annual basis, but every month too. Check the profitability of the previous month on the first of the next month. How is your profit is trending? Is it about the same every month? Is it increasing or decreasing (and how fast)?
Now you can predict future profit and correct course if your profit is flatlining or taking a nosedive.
#2 Calculate Gross Profit Margin
Gross profit is an important indicator of profitability level if you’re selling physical products. This number looks at how profitable your products are.
Here’s the formula to calculate gross profit:
Sales Revenue – Cost of Goods Sold = Gross Profit
Cost of goods sold could include labour, materials and overhead costs.
Gross profit margin looks at what percentage of profit you’re keeping compared to how much your product’s costing. The formula is:
Gross Profit / Sales Revenue = Gross Profit Margin
A higher percentage means you’re keeping lots of profit compared to product cost. Anything less than 50 percent means your product is costing over half of your sales revenue.
A lower percentage is fine as long as your sales volume is high enough to pay your expenses. What gross profit margin shouldn’t be doing is decreasing. If that’s happening, it’s time to raise your prices or find ways to cut product costs.
Is your gross profit margin good but your net profit is decreasing? The best idea is to take a look at your overall expenses, like overhead. Product cost isn’t your problem.
#3 Analyse Your Operating Expenses
Revenue increasing but profit decreasing? Check your expenses, they’re probably increasing faster than your revenue. When businesses grow, owners will sometimes invest the increased revenue back in the company without checking if their expenses are outpacing revenue.
Again, turn to your profit and loss statement and look at the line “total expenses.” Make sure you’re looking at expenses month by month and compare it to revenue month by month to find a trend. Are expenses creeping up to revenue? Have they already surpassed it? If so, it’s time to correct course and reduce expenses.
That said, some higher expenses are unavoidable, such as when you buy new equipment or add a new employee to the payroll. It depends on your industry; some require more capital than others.
#4 Check Profit per Client
Some clients are more profitable than others. A business owner needs to know which clients are contributing the most profit.
Surprisingly, the clients that seem the most profitable, ones who pay big fees, may not be. Even if you’re charging these clients more, you could be incurring more expenses, as well. Sometimes smaller clients may be more profitable because the revenue to expenses ratio is better.
Unfortunately, you can’t rely on your accounting software to measure profit per client. So you’ll have to do a little maths 😀
Total Project Fees – Project Expenses = Gross Profit per Project
Gross Profit per Project / Hours Spent on Project = Hourly Wage
Compare the hourly wage you receive for each project and then focus on getting more projects (and clients) that deliver a higher hourly wage.
#5 List Upcoming Prospects
Profits should be spread fairly evenly over the year to help with cash flow. But, this doesn’t always happen. A big project can take up a business owner’s Spring and then there’s little work over the Summer. This is partly because the owner is so focused on the project they forget to line up new projects.
Keep a list of potential new projects somewhere you can see it. If the list is short, it’s best to do some marketing to attract new business. Profitable businesses are growing, not stagnant, businesses.
We truly hope this article helps you to understand which numbers you should be paying attention to. However if this all seems like a massive headache and may as well have been written in another language then we are here to help you translate, in a way you’ll understand, so you can have clarity and peace of mind.
I want to Book a Discovery Call !
