This is the first in our series of blogs designed to help you better understand your business accounts. We’re kicking things off with the profit & loss report!
Working with many business owners over the years I have noticed that the successful ones are people who have a great focus on the importance of certain figures within their accounts.
As a business owner you put energy and expense into preparing company accounts for Companies House and HMRC but the real value of accounts is for your own use in managing the business. Most business owners are not accountants so how do you interpret your own figures?
In this series of blogs I’m going to introduce you to your accounts. Starting with the Profit & Loss Report, we’ll move onto the Balance Sheet later and I’ll go on to talk about some really important management figures you should have to hand.
The Profit and Loss Report reflects what has happened in your business over the period. It will reflect all the activities which have occurred and the financial effect of the activities. What you have delivered to your customers and how you have managed the business to keep it running in the short term and to make it sustainable for the future.
You’ll find this article more useful if you pull out the last Profit & Loss Report you have and keep it to hand.
Probably the most important figure to you and I expect you
are fairly clear on the value of your sales by week or month. This is a great start and an absolutely
essential fact about your business.
Whether this figure is a good figure, or a poor performance, only
becomes clear when the sales figure is compared with another, eg. The target
figure, or sometimes, last year’s figure.
How do you know if you’re making the right level of sales?
Sales are the value of what you have delivered in the period and not the value of your bookings or orders taken. Sometimes they’re not the value of sales invoiced as you may be invoicing for products or services that haven’t yet been delivered. If you have such a business then you may need the help of an accountant to be sure you are looking at an accurate figure.
Some people think this is the selling cost ie advertising and promotion, but it is not. This is the value of the component parts of your product or service. For manufacturers it will include the cost of materials, delivery, staff costs and the depreciation of machinery.
Restaurants must have a good idea of the costs associated with their menu. This includes the value of the various food elements, but also the staff cost for preparing the meals. Product costing is a science in itself and does need some time and thought to ensure you get it right.
Wholesale and retail cost of sales are simpler. They are always: the purchased product cost plus delivery cost.
Service businesses cost of sales can be more obscure and it is worth thinking about carefully. What items do you physically deliver to your customer? The major cost will be time; your time, your staff’s time, and sometimes, the time of a sub-contractor. Other costs could be materials; training products which are given to individual customers. When delivering bespoke services to a client don’t forget to include the cost of creating those specific materials or processes.
Travel operators may include maps and instructions as part of each holiday package, and some businesses will incur travel costs specific to a customer project.
Ensure you know which elements are the direct cost of the product or service you are delivering.
Once you’ve categorised your sales and your costs correctly the difference between the two is your Gross Profit. This is essentially very simple, but Gross Profit is the most important figure in your accounts. It’s this figure which brings your sales and the cost of sales together and it’s what you’ve worked for so keep a close eye on it!
This is your Gross Profit expressed as a percentage of your Sales. A single percentage movement in this margin can make a big difference to the profitability of a company because it is applied to all your sales. It has a ‘multiplying effect’. Hence monitoring is really important as costs can rise more than you realise, leaving your margin reduced. This means looking at your sales price and again at how you purchase or produce your goods or services.
Your margin may fluctuate depending on the mix of sales in the period. Some of your products or services may be more profitable than others, so your average margin will reflect the amount contributed at each level of Gross Profit. Changing your mix of business can be crucial in achieving higher profit levels.
If you get this wrong it can destroy your business so it’s absolutely essential that as you grow your sales you know that you are making sufficient Gross Profit to cover your overheads.
I’ll cover Overheads in my next blog . In the meantime, take a look at your sales and your cost of sales and see what profit you’re making on these activities.
If you'd like to discuss any of the above with a qualified Accountant
, then give us a call on 01273 882200.
In response to a request from one of our readers I’m going to address losses, which occur in a business on a regular basis for a variety of reasons.
There are proposals to reduce the VAT registration limit to capture more small businesses and increase tax revenue. 55% of small businesses are below the VAT threshold. Find out how you could be effected.
Time for part 3 of your business story blog series! This time we'll be talking about the result of your profit and loss account - the balance sheet!
This is a series of blogs to help you understand and analyse your business by understanding your accounts better. This week we're talking overheads and what your net profit figure means.