Are you looking to build your business?
As small business owners, it is easy to get distracted by the length of our to-do list and lose sight of the important factors that drive our business’ success. It’s also easy to ignore financial reports when we don’t know how to translate the numbers on the report into key insights about the health and value of our business.
As a certified public accountant and founder of Mazuma USA, I wanted to provide you with some of these key insights that can drive your business success.
Let’s start with the business basics—sales, also known as revenue. As business owners, we understand that the money we generate is our lifeblood. This is what allows us to function from day to day, earn a comfortable living, pay our employees, and invest in growing and improving our business.
But what do we do with those sales numbers after we see the reports? Increasing sales and revenue is important, but if that is the only number we focus on, we could run into problems in the long run. Driving up sales will not impact the bottom line if we have to increase spending to get there. That’s why the next numbers are important to evaluate as well.
2. Gross Margin
When you look at a profit and loss statement, you will see your revenue, your variable expenses (also known as cost of goods sold or cost of sales), your fixed expenses (expenses that don’t change from month to month, such as rent), your total expenses, and your net profit.
Gross profit is what you are left with when you take your total revenue and subtract your variable expenses. In effect, you are taking your sales and subtracting what it costs to make and sell your product or service. While this is an important number to keep tabs on, a much more telling number is your gross margin.
Gross margin helps you gauge your efficiency so you can work toward a healthier bottom line.
You can figure out your gross margin by dividing your gross profit (total revenue minus cost of goods sold) by your total revenue and multiplying that by 100 to get a percentage.
Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100
A low gross margin means you will want to make some adjustments to reduce your costs; a high gross margin means you are maximizing your profits.
Another way you can calculate gross margin is to simply divide your cost of goods sold (or variable expenses) by your revenue. You can then subtract that number from 1 and multiply it by 100 to get your gross margin.
Gross Margin = 1 – (Cost of Goods Sold/Total Revenue) x 100
As both your gross profit and gross margin increase, you will start to see improvement in your business. There is no one percentage that represents the ideal gross margin. Driving your gross margin higher at the expense of quality or customer service will have negative repercussions. As you are setting your goals, research healthy gross margins in your industry and look at the ways other businesses improve their efficiency. Understanding these numbers will help you set goals and work toward a healthier bottom line.
3. Net Profit
This is your bottom line. Your profit and loss statements should provide you with a net profit, but you can also easily calculate this by subtracting all your expenses (variable and fixed) from your revenue.
Net Profit = Revenue – All Expenses
Your net profit is the money you have available to pay yourself and invest in future ventures. It is also the money you will be taxed on at the end of the year, which leads us to the fourth number you should be tracking.
One problem many first-time business owners run into is not properly preparing for their taxes. No one wants a surprise bill come tax season.
The best way to prepare is to meet with a tax professional to create a plan. We encourage all our clients at Mazuma to meet with us twice per year to plan for the upcoming tax season. There are many variables that go into calculating your taxes, including spouses, dependents, what other jobs you hold, self-employment tax, deductions, tax credits, your tax bracket, etc. That’s why you can make a more accurate plan by sitting down with a professional. However, if that is not an option for you, the general rule of thumb is to set aside 25% to 30% of your net profit for taxes.
As you track these four different numbers over long periods of time, you will start to generate month-over-month and year-over-year comparisons that allow you to identify trends, strengths, and weaknesses in your organization.
Evaluating these numbers regularly will help you drive your business success to the next level.
Have questions? We’d love to answer them and talk to you about setting up a financial strategy for your business. Contact us today!