Business Success is More Than Profit
2019 is about to come to an end and while it is important for you to start thinking about tax time, it is also important to start thinking about your profit or lack thereof.
I hear it all the time “My P&L shows a profit, but I don’t have that much money in the bank.” I also hear “My P&L shows a profit but why does it feel like I never have any money?” Those are all great questions and ones you should be considering now that 2019 is coming to an end and 2020 is right around the corner.
To understand the answers to these questions you must first understand the profit as listed on the P&L. Profit does not mean money in the bank! Profit, on the P&L statement, means that you made more money than you spent on materials and supplies and your overhead expenses. This does not take into consideration any owner draws, any credit card payments, or any loan payments. It also depends on whether you have any outstanding invoices. If you have outstanding invoices and you run the report on an accrual basis that profit is going to include the amount of those outstanding invoices, your bank account will not. So how are you supposed to find out why you don’t have any money or truly how well, financially, your business is doing? You have more in-depth financial analysis.
There are several performance indicators that will help you see the whole picture of how your business is financially. Let’s go over the top 3 and one good business practice.
Gross Profit Margin-Gross profit margin tells you how much money you receive from your sales after paying for materials. For example, if your gross profit margin is 10%, that means for every $100 in sales you are only getting $10. That isn’t even enough to be paying the employee that went out on that job. This will tell if you need to increase prices or reduce the cost of your materials.
Net Profit Margin-Net profit margin tells you how much money you receive from your sales after your materials, overhead, taxes, and interest charges. For example, if your net profit margin is 10%, after all your expenses, you are only receiving $10 for every $100 in sales. This will tell you that you may have to cut expenses.
Cash Flow-This comes back to profit vs how much money is in the bank. Cash flow is just that, cash received - cash paid out. If you received $100,000 for sales but you paid $50,000 in payroll, $10,000 in overhead, and $10,000 in loans, credit cards, and owners draw payments throughout the year that only leaves you $30,000 cash out of the $100,000 in sales you created. (this still doesn’t mean it will equal what is in your bank account as there are other things that affect the bank account, which we will not go into)
Budgeting-You may associate budgeting as being for large companies but it’s not, it is also for smaller companies as well. Basically, a budget helps you keep your finances under control by keeping track of how much money you’re spending and where it goes. I know you can keep track of that information in an income statement but having a budget helps you improve decision making, plan, and identify problems before they occur.
As you can see net profit on the P&L can be a bit deceiving. I am not saying that you should not pay attention to the P&L because you should but understand the P&L does not show an entire picture of how your business is running. You can show a profit while running your business in the red! This is not sustainable.
If some of this seems too overwhelming, don’t be afraid to hire a financial coach to help you. Financial coaches, like Collins Bookkeeping Services, are not here to judge, they are here to help you get your business be a success!
Tracy Collins | 12/06/2019