That’s a mouthful small business profitability analysis but really it’s a simple statement regarding information you need to run your enterprise with.
The starting point has to be sales because, without sales you don’t have a business. When you have sales you should have profits! The profit pays the bills associated with the business.
So, what do we need to analyse? in the normal scheme of things we look at our gross margin or gross profit, simply we buy for X and sell for Y. Now we have to consider how much of the gross do we get to hang on to.
Gross profit = Net sales minus the costs of goods sold.
(As a reminder : Net sales = gross sales less any returns and discounts.)
Operating profit = Gross profit minus selling and administrative expenses
(Administrative expenses = salaries, payroll taxes, benefits, rent, utilities, office supplies, insurance, depreciation, etc.)
Operating profit includes all expenses EXCEPT income taxes.
Net Profit = Operating profit (plus any other income) minus any additional expenses and minus taxes.
Net profit is what is known as “the bottom line.”
Again in simple terms money in and money out.
Years ago I owned and ran a powder coating plant, we coated a variety of metal products from beer pump casings to electrical boxes. One of our biggest customers produced shelving units for supermarket fridges. Because the contract was quite big and regular our price per sq foot for coating was quite low.
Each year just after Christmas I would sit and analyse the business ready to make changes for the new year. I discovered my biggest customer was my least profitable, time and materials spent was way higher than the financial return..you might say we were being busy fools.
The answer to the problem was that the prices quoted were too low to make a decent profit. There some alternatives, one ask the customer for an increase, two – could we shave the cost of the paint or three – drop the work and replace it with more profitable work.
Any business owner knows that it is much harder to get a new customer to replace an existing one however, as luck would have it a new customer was found who had high volumes of good clean work for our plant. After a meeting with the company making the shelving they agreed an increase in their quoted prices and all was well.
Let’s get back to the topic, you or your book-keeper needs to have a cash flow forecast where you can put actual sales and overheads and cash flow projections for the future, this is what this website is about, if you don’t have one already then, I urge you to get one started right away, make sure you know where your business is at. Read more
Once you have your projections you will be easily know how to analyse profitability.