If your business sells more than one type of product or service, it pays to know how profitable each category is. The easiest way to achieve this is to set up your accounting system to break it down. Set up an account for each type of income as well as a cost of sales account, as you will then be able to see how much gross profit each contributes to the total and which needs to be focused on. 1 July is a great time to start doing this, as your profit and loss is cleared out at the end of year.
Key Performance Indicators (KPIs) are another great way to get a detailed view of what’s happening. Have a think about what your business KPI’s are, and start measuring them:
- Income per salesperson
- Income per square meter of retail space
- Income per service person per hour
A good place to get inspiration about KPIs is by looking at your industry benchmarks. Google “business-benchmarks” and you’ll find resources to help with this.
The start of July is also a good time to review your pricing. If it’s written into your contracts or terms of trade, that’s great, if not it might be a good time to consider it. Costs are constantly increasing and you need to adjust your prices to ensure you maintain your gross profit margin.
Understanding your income break-even point helps to provide clarity about sales targets. Your break-even point is the amount you need to sell to cover costs and overheads. Obviously you want to make a profit and understanding your ‘break-even’ is a great place to start compiling a target to make a profit.
If you give discounts, have you calculated how much you need to sell to compensate for the discount? Extra sales to cover a discount is an often a misunderstood factor – remember a discount comes straight off your bottom line, as costs usually stay the same.
2. Costs and overheads
If you’re competing in a price sensitive market, the best way of producing profits is via the efficient management of costs and overheads.
Industry average cost and overhead percentages are a good thing to know, as they allow you to compare your own business to see how you’re performing. If you fall short of the benchmark you can investigate what others are doing and find ways to improve.
If you sell products, close management of stock holdings will have a positive impact on both profit and cashflow. Stock needs to be managed in-line with sales forecasts of minimum and maximum levels to avoid surplus stock or not having enough inventory. Monitoring purchasing from suppliers provides ammunition to approach them for better pricing and terms and the introduction of freight efficiencies can create big cost savings – for example, you could organise fortnightly deliveries instead of weekly.
If you sell services, close management of jobs that will have a positive impact on both profit and cashflow. Jobs should be managed so that they’re in progress for the minimum time, reducing wastage, rework and travel time will have a positive impact. A good question to ask is: “How many hours do I spend selling, compared to what I’m paying for?” This assists in gauging whether staff are spending their time productively – their time is a valuable resource and needs to be maximised wherever possible. Today, there are some very cost-effective systems for measuring staff productivity.
Overheads differ from costs, as they occur constantly whether you sell anything or not. Overheads include things like wages, rent, postage, printing, stationery and so on. A close review of overheads can uncover many opportunities for saving, such as by looking at every line of your profit and loss report and asking yourself “How does this contribute to the business and can we do it more efficiently or cost effectively?”
If you offer terms to customers, speeding up their payments will improve cashflow. Review your terms of trade, invoice timing, follow-ups to slow payers and debt collection practices.
If you receive terms from your suppliers, make sure you make the most use of these and ask for longer payment terms where possible. For each day you pay early, you’re giving away vital cashflow you have to find elsewhere. Monitor the amount of business you do with suppliers and use it to negotiate better terms.
If you run a service business, try to negotiate progress payments for big jobs, as this frees up vital cashflow rather than you having to borrow money to meet the payments and then pay interest.
Finally, have a financial roadmap drawn up, which includes both a budget and cashflow forecast. These will help you to stay on top of your profit and cashflow. A cashflow forecast especially will help you to proactively manage the peaks and troughs throughout the year, give you peace of mind and vital funds to take advantage of opportunities which will help you to grow your business.
– Sue Hirst is from CAD Partners CFO On-Call, a team of financial and business advisors who work with open minded people committed to business growth and achieving success.