Archive for the ‘cost’ category

Business Profit & Loss

June 26th, 2015

Profit & Loss Dice

As a business owner you must continually focus on managing profit and loss to not only stay in business, but to grow and thrive. Profit is the money left over after paying all the expenses. A loss results from expenses exceeding the amount of sales a company makes in a specific period. Companies must manage their profit and loss statements, also known as income statements, to keep earnings positive, and expenses under control and in line with revenue.

Financial Assessment

Managing profit and loss begins with an assessment of your company’s current financial situation. Review the current profit and loss statement and compare it to the company’s last two or three years of historical data. An accountant can use this information to establish a set of performance benchmarks for the company’s average revenue and expense levels.

Analytical Tools

Have an accountant prepare analytical tools such as an income statement spreadsheet that shows every expense as a percentage of sales. This will allowing you to isolate costs that could contribute to decreasing profits. Perform this analysis for, ideally, three years of historical data. Expenses as a percent of revenue are compared for each year to reveal trends that show expenses raising or falling as a percent of sales over time. Some costs, such as the cost of goods sold, will rise with sales increases because they represent the raw materials and labor used to make the products you sell. Rent, administrative costs and some utility bills should remain the constant, regardless of increases in sales.

Explaining Expense Growth

Your accountant should perform additional analysis to investigate and explain the growth of expenses over time. This can reveal valuable information about the use of resources and their cost oversight. External factors such as the economy and rising prices also can contribute to cost increases. You need to find out which of these factors is involved in order to determine which might be controllable.

Sales Review

Next the accountant should review the company’s sales. Depending on various events and conditions, even when internal expenses have been well-managed and cut as low as possible, the company will still suffer a loss if its sales drop below its expenses in any given period. In this case, the company must make important decisions about how and why sales are generated, but may also need to consider discontinuing certain unprofitable product or service lines, selling off assets to free up capital and discontinuing investments in any projects that do not generate revenue.

 

Set Your Prices by Knowing Your Costs

January 20th, 2014

It seems like a simple fact of business; to turn a profit your prices have to be higher than your costs. Is it really as simple as just adding some percentage to your costs to make your company profitable? Actually, it is. The hard part is determining your true costs.

With product-based businesses, setting prices starts with a markup on the product costs. Service businesses can start with a markup of an hourly rate, for the employees and/or owners providing the services to the clients. Those costs should be starting points, but many new business owners use these alone as a basis to set prices. For many new small-business owners, figuring out the complete costs of what they’re selling can be difficult. However, not knowing the true costs can result in underpricing products and services.

The price floor is the absolute minimum at which you can set your prices without sustaining losses on each sale. The price ceiling is the absolute maximum price the market will bear. The price you charge for your products or services will fall somewhere in between.

Here’s what your price needs to cover:

  • The immediate cost of what you’re selling
  • A portion of your selling and general expenses
  • A reasonable profit left over for you

Include every component of your cost-of-goods-sold as you work the numbers for a product-based business. For a service business, use a reasonable hourly rate as your starting point; for yourself (if you’re not counted as an employee) and remember to add on the costs of benefits and employment taxes. Pull the selling and general expenses right off your profit and loss statement; if you have figures from two or three periods to work with, take an average. As for your desired net profits, add on a reasonable percentage for your industry. For example, someone selling original artwork could expect to see a higher profit percentage on each individual sale than could someone selling one-size-fits-all rubber noses.

Is Your Budget Incomplete?

October 8th, 2013

Is your budget incomplete?Estimating and matching expenses to revenue (real or anticipated) is important because it helps business owners to determine whether they have enough money to fund operations, expand the business and generate income for themselves. Without a budget or a plan, a business runs the risk of spending more money than it is taking in or, conversely, not spending enough money to grow the business and compete.

So you assemble a budget spreadsheet that starts with your projected profit, then accounts for the operating expenses required to generate that profit, and calculates the gross profit margin, and then estimates the required sales revenues. You look over the results and decide that the profit goal is doable because the sales revenues are realistic and the required expenses are complete. But are they? Have you considered all of the following?

Purchase Price vs Landed Price
Does your budget account for the difference between the purchase price for a product and the landed price? The landed price is what really matters, because it includes the costs of freight, duties, taxes, storage, etc. Knowing the true cost of getting the product into your hands is crucial when setting the price and insuring profitability. Clearly it is advantageous to reduce the cost of each or any component of landed cost. Each one will allow the seller to lower the final selling price or increase the profit margin associated with that sale.

Slow Growth
Many entrepreneurs don’t account for how much money they will spend if their idea does not take off as fast as they hope. When budgeting, make sure to create at least one “very worst case” scenario that does not have much or any growth, just so you know what will happen if it all goes wrong.

The Effects of Scale
Scaling may affect more areas of your business than you can anticipate. Ongoing processes such as training new employees and maintaining quality control are just some areas that might get exponentially more difficult, without even factoring in the effect of any new operations. Be sure to budget in the money and time to make systems and procedures more efficient, as new problems related to scale will inevitably arise.

Insurance, Equipment and Software Applications
Three of the biggest expenses that may surprise you as an entrepreneur are:

Insurance: You need to budget in much more than you pay as an employee for health, disability and business insurance.

Equipment: Will you need additional equipment and office furniture to provide the production capacity that your profit projection required? Even simple items like tools, racks, chairs and file cabinets can add up to substantial costs.

Software: You’ll need to purchase licenses for each user.

The Cost of Networking
Entrepreneurs sometimes forget how expensive it can be to do networking in the right places. Conferences, for example are great for networking. However, ticket costs, hotels and transportation to conferences add up. Even if most of your networking is at free or low cost events, consider how much money is spent taking people out to lunch and coffee to network with them one-on-one afterwards.

The Costs at Home
When you’re caught up in the fast pace of running and growing your business, it’s easy to forget that there needs to be at least enough money to put food on the table at home. Even if you cut your personal expenses down to bare bones, they do still exist. Make sure they make it into your budget, rather than stressing about them down the line.

Paying Taxes
It’s easy if you’re self-employed, especially if it’s in a start-up, to forget to put enough money aside for taxes. Budget 15-20% of gross revenue or 35% of net revenue (until you know your business better) for paying the taxman. It would be advisable to put the money aside in a separate bank account every month so you’ll always be able to make your tax payments in full and on time.

Unpredictable Costs
There will always be costs you couldn’t have predicted, and because of this it’s important to have a buffer-fund of as much money as you can spare to handle those server crashes, extra hires or other incidental costs you couldn’t have known to figure into the official budget. Consider that an extra 10% of your budget should be included in a Miscellaneous Expenses line item on your budget spreadsheet.

Review the Business Periodically
While many companies draft a budget yearly, small business owners should do so more often. In fact, many small business owners find themselves planning just a month or two ahead because business can be quite volatile and unexpected expenses can throw off revenue assumptions.

Bottom Line
Budgeting is an easy but essential process that business owners use to forecast (and then match) current and future revenue to expenses. The goal is to make sure that enough money is available to keep the business up and running, to grow the business, to compete, and to ensure a solid emergency fund.

5 Ways to Become Profitable

August 23rd, 2013

5 Ways to Become Profitable

All businesses want to make money. And of course if they don’t, then even those with great products or services will fail. Making more money and becoming a profitable business is what it’s all about. Here are five strategies that can help.

1. Change the Way you Operate
Analyze your existing business models and try to establish ongoing revenue streams. If your customers are buying infrequently then you might, for example, sell an ongoing re-supply program or a maintenance plan instead of just a one-time or stand-alone sale. Establish a relationship with new customers and change the relationships with established customers to tie the profitability of their business to your products or services.

Look around, analyze and learn from what your competitors are doing. Think about what you can innovatively apply from those lessons to your business.

2. Become Visible and Connected
If you have a long established company with a great reputation, loyal customers and respected industry experience, then you are probably running a successful business. But along comes the new guy who puts his business on the Internet and posts his credentials all over the place. Everyone, including your customers, can find him. You can’t sit there and assume that just because people know who you are you will remain dominant.

You have to have a marketing plan that addresses the current methods used by potential customers to find the products or services that you offer. When they search the Internet, and you’re not there, or they can’t find you, then in 100% of those cases you will not get their business. A lot of older small businesses don’t have a web-presence. If that’s you, or you don’t have a strategic marketing plan in effect, then you need to take your reputation online through social media, a website and a blog to connect with customers, including the ones you already have, or you won’t have them much longer.

3. Raise the Bar on Marketing
A lot of small businesses think about sales but not marketing. You can’t just go out and try to make sales; you have to have a plan with a strategy coherent to your industry, your company and the prospects you want to target.

In order to track the leads your marketing program generates, you will need customer relationship management (CRM) software, although a well-designed Excel application may be OK as you get started.

Consider using search engine ads, email marketing and other such online advertising.

Give your business an immediate web presence through social media networks including LinkedIn, Facebook, Twitter and YouTube.

Offer tutorials, demos, or new certification sessions as webcasts or podcasts for immediate download.

All these types of promotional vehicles need to be on the table because that’s what your competitors are doing.

4. Make Every Person a Salesperson
Some employees don’t think they’re there to promote sales or the business and are just there to collect a paycheck. But those days are gone and those people are the first to be laid off. Everyone should be an income-producing part of the business no matter what their main function might be. Everyone needs to pitch in to help cut costs, sell, and network on the web. Motivate employees to spread the message and reward those who make the extra effort or are producing new business.

5. Streamline Your Costs
If a business is having profit problems, the options are pretty straight forward. You can increase sales, decrease expenses, or do both. Due to the sluggishness of the current economic recovery, sales may not be where you would like them to be, and increasing sales may be a slow road. Decreasing expenses may be a faster way to turn things around. Try fitting expenses into three categories: fixed costs, such as rent and other overhead, sales-related costs that are tied to producing revenue, and discretionary expenses, such as new equipment and bonuses. Examine every single line item looking for ways to save, even with the fixed costs. Telephone and insurance costs may be fixed, but they are also competitive, and therefore negotiable.

Making Any Money? Can You Tell?

March 11th, 2013

Profit means making more money than you spend. Many confuse profit with income. As a result, they don’t understand why all their income isn’t getting them ahead; why no one wants to invest in their high-sales company; why the bank won’t extend their line of credit.

Let’s look at the most basic way to tell if your business is actually profitable, making money, not just recording sales.

Most small business people are very good at tracking their income. Each widget sale is recorded in a spreadsheet, and each payment from a customer or client is recorded in the checkbook. Each is totaled frequently.

Actually, that’s not what you made. That’s income, not profit. It’s what’s coming in. In order to determine profit you have to subtract what is going out from what is coming in.

(PROFIT = INCOME – COSTS)

Calculating Costs
Your business has two basic types of costs; fixed and variable. Fixed costs are costs that don’t change based on your level of business activity, such as rent. Whether you produce 100 widgets per day or 150, your rent will stay the same. Variable costs are directly tied to how many units of goods you produce. If you need $10 of screws to produce 100 widgets, you will need $15 worth of screws to produce 150 widgets. The cost of screws is a variable cost.

Fixed Costs
For the most part, fixed costs can be closely estimated at the beginning of the year and accurately projected for the next 12 months. For example, you know the rent on your facility is $5,000 per month. You may know of, or expect, a rent increase in April to $5,500 per month. As a result, your fixed cost for rent will be $64,500 for the year (3 months at $5,000 plus 9 months at $5,500).

Fixed costs include things like rent, depreciation, licenses, equipment lease payments, some taxes, and indirect labor.

Variable Costs
Variable costs are those that depend on your production level. As the production volume goes up, the variable costs go up as well. If I make lamps, I have to purchase one lamp pole, two light bulb fixtures, a lamp shade and five feet of wire per lamp. If a lamp pole cost $3 and I need enough to make six lamps, my lamp pole costs will be $18. However, if I need to make 20 lamps, my lamp pole costs will be $60. I can estimate variable costs at the beginning of the year, but my estimate will not be as predictable as was my estimate of fixed costs.

Variable costs include such expenses as cost of materials used in manufacturing, certain utilities, some taxes and fees, and direct labor.

Telling the Difference Between Fixed or Variable Cost
Some costs the business incurs, such as labor will have to be split between fixed costs and variable costs. The wages you pay production labor, called direct labor, is a variable cost. It is tied to how many units you produce. Other labor costs, such as the salary you pay your administrative assistant, are fixed costs. These indirect labor costs are not tied directly to production levels. If your production increases from 100 widgets per month to 150 widgets per month it is unlikely you would hire an additional administrative assistant.

Utilities are another cost that is split between fixed and variable costs. Your phone bill, for instance, probably won’t change much as production increases or decreases. However, the demand for electrical power, and the cost of it, will increase as production lines run longer and lights stay on further into the night because of increased production.

Income
When someone pays you that is income. Income is usually related to production levels, but is not tied to it directly.

You may produce more or less than you sell. For instance, if you have 100 widgets in the warehouse when you receive an order for 150, you only have to produce 50 additional widgets. If you make widgets for skis, you may make 20 widgets every month during the summer even though you don’t sell any, just so you have enough in the warehouse when winter arrives.

So income is when you actually get paid, not when you make the product you are going to sell. Total income is just the total of all your payments received during the year.

Break-Even Analysis
The break-even point is the production level where your income for a certain number of units produced equals your fixed costs plus the variable costs for that number of units. For instance, you have fixed costs of $500, variable costs of $20 per widget, and you sell the widgets for $25 each, so your break-even point is 100 widgets.

If you reduce your fixed costs to $400, your break-even point is 80 units. Or if you cut the cost per unit from $20 to $15, your break-even point drops to only 50 widgets.

 

Profit
Any sales beyond the break-even point are profit. In the final example above (fixed cost $500, variable cost $15 each, income $25 each) your break-even point is 50 units. If you produce 50 units and sell 50 units you will break even. Your costs will equal your income. You will have a profit of $0. If you sell less than 50, you will have a loss. If you sell more than 50 you will have a profit.

For example, if you sell 70 units your fixed costs are $500 and your variable costs are $1050 ($15 x 70), so your total costs are $1,550. Your income is $1,750 ($25 x 70) and your profit is $200 ($1,750 – $1,550).

Bottom Line
To make a profit, you must be able to sell each unit for more than it cost to make it and you must be able to sell it for a price high enough to cover both the variable cost of making it and its share of the fixed costs.

This is true whether you are selling widgets, boxcars of apples, dance lessons, or hours of financial consulting.