When looking at overheads it is important to look at them as a percentage of revenue. This can help you really get perspective on where you are spending and what percentage of revenue and the years budget. A round 1k spent on advertising might seem reasonable but if you know this 10% of your revenue you might think twice. ake a large increase, whereas regular small increases are much easier to achieve.s important is because business growth is often the killer of small businesses. How is this so? Because so many numbers besides Revenue are important to profitability if the other numbers aren’t being managed right revenue growth will just exacerbate the situation. If it’s not a good situation it won’t get better but much worse. Revenue Growth is cause for celebration but it also causes for caution and close management.
Do you ever look at the reports from your accounting software and get bamboozled by all the numbers? Do you not bother printing out the reports at all because you aren’t sure which numbers to look at and you don’t have the time anyway?
There is no shame in having answered yes to any of these, a typical set of financial reports can be number loaded and daunting. Of course, all of your figures are important but we aim to breakdown the seven most critical. Most critical because these numbers are the drivers of your business rather than the result.
So what do we need to look at:
1. Revenue Growth %
2.Price change %
3. COGS (Cost of goods sold) %
4. Operating Expenses %
5. Days receivable
6. Days payable
7. Days inventory/ Work in progress
Revenue Growth %
Business owners focus a lot of attention on Revenue and making sales and this is obviously critical. But what did that sale cost your business? As soon as you sell something, and often well beforehand there are costs involved - these can be inventory costs, advertising, marketing etc. If these costs exceed your revenue then you are making a loss and heading for problems. The reason Revenue Growth % is important is because business growth is often the killer of small businesses. How is this so? Because so many numbers besides Revenue are important to profitability, if the other numbers aren’t being managed right revenue growth will just exacerbate the situation. If it’s not a good situation it won’t get better but much worse. Revenue Growth is cause for celebration but it also causes for caution and close management.
Price change %
It can be tempting to sell your product and service for the cheapest price possible particularly when starting out. This is fine, but if you’re not covering costs at the price you can’t last long.
You may discount some products or services in order to gain business and in the hope that this will lead customers to buy more profitable ones.
A trap many businesses fall into is failing to review and increase prices regularly by small amounts. Failing to do this can cause margin squeeze. This means, your gross profit suffers, due to the increased cost of delivering the goods or services. Customers can get a shock if you’ve never increased prices and suddenly make a large increase, whereas regular small increases are much easier to achieve.
Example, you may visit say, Pret for Lunch. They won’t tell you the price regularly goes up, but you may notice it. The cost of your lunch was £10.90 when last time it was £10.50. That was a less than 5% price increase. It was barely noticeable and you, as a customer, won’t take your business elsewhere for the sake of an extra 40 pence. This increase is probably quite justified with increased petrol and costs to deliver the product.
Many business owners fear losing customers by putting up prices. The reality is that you may not lose as many as you think. If you do lose a small number of extremely cost-conscious customers, it may not be such a bad thing. Modelling can show that increased price and reduced overall revenue could, in some circumstances, actually have a positive impact on your business.
Cost of Goods Sold’ means the costs incurred to get the product or service to the customer, before taking into account Overheads. Also referred to as Direct Costs’ or ‘Variable Costs’.
A reduction in COGS can be just as impactful or in some cases more so that an increase in sales.
Often a little attention to what makes up COGS and some negotiation or investigation with suppliers for better prices can pay huge dividends on Profit.
If you are a service based business, attention to work practices can have the same effect on the Gross Profit. E.g. knowing how many labour hours you are selling compared to those you are paying for, provides opportunity to investigate differences and tighten up processes.
When looking at overheads it is important to look at them as a percentage of revenue. This can help you really get perspective on where you are spending and what percentage or revenue and the years budget. A round 1k spent on advertising might seem reasonable but if you know this 10% of your revenue you might think twice.
Your Overheads % should be linked in with. your budget. if you don’t have a budget it can be very difficult to know if overheads are reasonable anyway. Very few businesses have a budget, which makes it difficult to know how you are doing during the year.
If you are trying to reach a goal in business then you need a budget. Not having a budget in business is like trying to find a new destination without satnav or a map.
Is the number of days, on average, your customers are taking to pay invoices. Managing this number can have a huge impact on cash-flow. If for example your Accounts Receivable Days is current seventy and you can get it down to say fifty, you could be putting tens of thousands of pounds back into your bank account. If your business is growing rapidly you need to know how much Accounts Receivable Days are changing compared to Revenue growth. This is because if it’s not comparable you will experience cash-flow squeeze and could run out of working capital.
Is the number of days, on average, you are taking to pay your suppliers. This number is just as important as Accounts Receivable Days in that it can have a big impact on your working capital situation. It’s easy to ignore potential better terms to be had from suppliers because you get so focused on Revenue. Some small changes to procedures relating to Accounts Payables can pay big dividends in your bank account. If your business is growing this could be critical cash for funding growth.
Is the number of days, on average, that goods for sale are sitting in your store-room, from when they are delivered by suppliers, to when they are shipped out to customers. These goods often have to be paid for before they have been sold. This means you have had to spend valuable working capital to have the stock sitting there waiting to be sold. If you can manage this situation better, and reduce the number of Inventory Days, this can have a big impact on your bank account and working capital situation. It’s very tempting when a salesperson calls and offers you a discount to buy more stock. It’s useful to consider the amount of working capital that will be tied up in that stock, compared to the discount being offered. If you are borrowing funds it’s also important to consider the amount of interest payable on those funds tied up in slow-moving stock.
If you are in a service-based business Work in Progress (WIP) Days is very similar to Inventory Days, in that your ‘stock in trade’, is the labour and materials you have to sell. If you are in a service-based business Work in Progress (WIP) Days is very similar to Inventory Days, in that your ‘stock in trade’, is the labour and materials you have to sell. Slow WIP days can be just as dangerous to cash-flow and working capital as Inventory Days. Anything you can do to tighten up processes and speed up the time work is ready to be invoiced will pay dividends in your bank account and interest expense.
Needing some help with your financials? CB Accounting now offers onsite (Edinburgh and surrounds) and remote financial training. For enquiries please email email@example.com