For most small and medium business owners, you go into business to do what you love doing – whatever that might be. We know better than anyone that you didn’t necessarily go into business to be number savvy (unless that’s your thing!) so how can you make life easier when it comes to managing your business and understanding how it is performing? How do you know what areas are improving, or what needs your most urgent attention? If you know the numbers, then answering those questions are super simple.
So, let’s show you some examples of numbers you can easily and quickly monitor to make sure your business is on the right track.
Understanding your Profit & Loss report: What do the numbers mean?
The first thing you should be looking at when it comes to knowing your numbers is your Gross Profit Margin and how it’s tracking month to month, year to year. It’s a simple calculation to show you how much of every dollar you sell is left once you pay for your purchases (or the cost of goods sold).
Gross Profit Margin = (Sales – Purchases) / Sales
To calculate this as a percentage, simple multiply the end result by 100.
By comparing your Gross Profit Margin month by month, and year to year, you can ensure if what you’re selling is priced correctly for the rate it is costing you to purchase. This is especially useful for businesses that buy and sell goods or stock, whether you sell services or not.
Remember – your gross profit margin should always be big enough to cover your expenses and overheads.
Following on the same line as the gross profit margin calculation, the next ratio you need to be looking at when you look at your GP is your net profit.
Net Profit = Total Sales – Total Expenses
Put simply, net profit is everything your business has earned less (almost) everything your business has spent money on. The only exception to this are things like drawings, loan repayments and stock that you have bought but have not yet sold.
Net profit is always found on the last line of the Profit and Loss report – it quite literally is your bottom line. It’s important to recognise changes to your net profit quickly by reviewing each month as it happens, and understanding what might be affecting this number.
An easy way to identify any changes to this number or identify possible trends is to calculate your Net Profit Margin.
Net Profit Margin = Net Profit / Total Sales
Again, to calculate as a percentage, simply multiply the end results by 100.
By looking at this number regularly, you can spot changes and fluctuations that might just be seasonal or it could be caused by something that you need to dig a bit deeper. As always, more net profit margin is better, but you should still compare this to industry standards to ensure your business is performing in line with others who do similar things to you. If you notice your net profit margin dropping, you need to take action quickly. Check your expenses and perhaps use a few of the following ratios to monitor what’s actually going on in your business.
Expenses / Sales
This ratio shows you if your expenses are increasing out of proportion to any expected business growth (or decline). The lower your expenses to sales ratio, the higher your profit will be. If the ratio is increasing over time, it’s a warning sign that expenses might be getting out of control and provide an opportunity to review your costs.
You can drill these down even further by selecting certain expenses, for example Marketing and Advertising. Say you’ve purchased a 3 month pack of radio adverts, how can you tell if you’re making more sales? Compare your advertising expense to your sales as a ratio. If the radio advertising is effective, you will begin to notice an increase to sales.
Another example is Wages, if you compare your wages expense to sales on a monthly basis you can identify trends if your staff are costing you more money than what you are selling, or are being pretty efficient when it comes to how they are spending their time when they’re at work.
It always goes back to the numbers. If you know your business numbers, then you know what is happening in your business and are able to react to any changes that can potentially make you even more successful than you already are!