Category Archives: Accounting

May 2017 Newsletter – Determining the Core Profitability of Your Company

Determining the Core Profitability of Your Company

Recently, several of our clients have been going through the process of either buying another business or selling their company. During the requisite work related to these actions there have been many discussions regarding how to analyze the profitability a company.

The profitability of a business is almost the sole determinant of whether it will succeed, making it the most important part of your business’ Financial area. Indeed, it is so important that the abundant profitability of a business can cure a number of “evils” throughout it. If you have a wildly profitable business, you can make a ton of mistakes in various areas of your business and still be successful because you have a large cushion for error.

When most people consider an organization’s profitability they think of the Net Income/Loss of the company. However, you should also consider another key tool you can use to measure and gain insight into a business, it’s Gross Profit. The significance of Gross Profit is that it is a “core” financial measurement, whereas Net Income/Loss has many factors that effect it and perhaps distort its value as an indicator of a company’s operations.

Gross Profit Analysis

Small Business Planning in Atlanta, GeorgiaThe formula for calculating an organization’s Gross Profit is:

Revenue – Cost of Sales = Gross Profit

In the above equation, your company’s Cost of Sales (sometimes called Cost of Goods Sold) are those expenses of your business that are directly related to the production of your Revenue as compared to overhead expenses. For example, if you were a home builder you would produce your revenue by building and selling houses and the costs that would go directly into producing a house (your product) would be:

  • The wages and salaries you pay your employees to build the house
  • Materials (lumber, drywall…) that would go directly into the house
  • Sub-contractor payments for areas that your business will not complete itself (e.g., plumbing, heating and air conditioning)
  • Supplies (you buy 500 lbs. of nails that you use on four different houses)
  • Rental of a bulldozer to clear the land and scaffolding to erect the house

All the above costs would be considered Cost of Sales because when you sell the house, these are the costs that were necessary to produce your product (a house). Once you subtract the direct expenses (your Cost of Sales) from the Revenue that you received from the sale of the house, you have the Gross Profit. What is the benefit of knowing your Gross Profit?

How Efficient is Your Business?

Your Gross Profit (also known as Gross Margin) shows how efficient your business is at producing its Revenue. This information is instrumental in enabling you to analyze your cost of Small Business Planning in Atlanta, Georgiasales and thereby increase your profitability. Gross Profit analysis looks at the Cost of Sales of your business and compares that to your gross revenue in dollar terms and on a percentage basis. Additionally, you can compare your Gross Profit percentage to your competitor’s or industry averages to provide information to improve your profitability.

There are two main benefits of having a higher Gross Profit percentage. First, it means that your business is more “profitable” (i.e., more efficient) in its revenue generation than your competitors. This is key because if you have two similar companies in the same industry and one’s Gross Profit Percentage is 75% versus the other one’s 50%, that means the first organization is 50% more efficient in producing its Gross Profit than the second one.

Relatedly, you can gain even more insights by comparing both your overall Gross Profit and at a component level – Cost of Sales (Labor, Materials, Supplies, Contracted Services, etc.) on a percentage basis to industry averages. Knowing this information is the first step to improving a company’s operations.

Greater Gross Profit Yields More Flexibility

Second, your greater Gross Profit percentage provides you with more flexibility with regards to how you choose to operate your business. This potential flexibility affects every area of your company by providing you the freedom to make decisions and to choose options that otherwise you could not select because of having constrained finances.

A good analogy to use for this “flexibility” is to imagine you were looking at purchasing one of two different sponges; one which absorbed 1 cup of water and one which absorbed 2 cups of water. If each sponge was about the same price, you would purchase the second one, because its ability to absorb twice as much water as the first one.

Ability to Absorb Overhead Expenses

Think of a business’ Gross Profit as its ability to absorb overhead expenses. If you have a higher Gross Profit percentage than your competitors and your industry provides healthy Gross Profits, your business has a greater ability to absorb overhead expenses (i.e., spend money) than do your competitors.

This greater ability to absorb overhead expenses can provide you with many options, for instance you could:

  • Invest more in your Marketing and Sales area to generate additional revenue
  • Expand your business
  • Pay your employees more or provide more fringe benefits to them to increase their satisfaction and morale
  • Pay yourself more or increase your fringe benefits
  • Pay off business debts
  • Distribute more money to the owners of your business

With enough Gross Profit, you can do almost anything!

“This Does Not Apply to Me”

Small Business Planning in Atlanta, GASome business owners may be thinking “this does not apply to me” because we are a consulting, health care, internet marketing, etc. company and not a manufacturing, retail, or distribution business. The Gross Profit Analysis tool applies to all companies because unless you can magically produce your product (I am using the term “product” in the loosest sense of the term) your organization will incur some costs to produce its product. By properly calculating your Cost of Sales and Gross Profit you will obtain great insights into the efficiency and true Profitability of your business.

The mechanics of doing the above are quite straightforward; the only problem is that many businesses do not include costs that are truly Cost of Sales in the Cost of Sales section of their Income Statement, but instead treat these expenses as overhead expenses. The result of doing this is that the true operational efficiency of the business is distorted because its production costs are not being reflected in the most insightful manner.

Performing a Correct Gross Profit Analysis

To have accurate financial statements with which to perform a correct Gross Profit analysis, go through your Chart of Accounts overhead expense section and reclassify any accounts that should be Cost of Sales accounts. Then re-produce your Income Statement and re-do your Gross Profit Analysis.

In summary, by using Gross Profit as an analysis tool you will gain insights how you can minimize your Cost of Sales, which thereby maximizes your Gross Profit. When this is coupled with keeping your overhead costs under control you will improve the profitability of your business, provide more flexibility and reduce your need for financing.

If you need assistance in using Gross Profit Analysis in your company to maximize your profitability please contact us using the below information so we can show you how to use this tool to take your business where you want it to go.

Fountainhead Consulting Group, Inc. is an Innovation and Business Planning firm. During the past 17 years we have shown over 1,200 companies how to achieve their goals by using our unique, comprehensive and systematic, innovation, business planning and growth Structure of Success™, Innovation Academy™ and FastTrak Innovation Program™ methodologies. Using the components in these methodologies, each month we examine an aspect of how to transform your business or organization into a true 21st Century operation.

Office phone: (770) 642-4220

May 2016 Newsletter – How to Find the Big Money

How to Find the Big Money

Everyone wants to have a “successful” business. But what does the term successful really mean?

There are many aspects to having a successful company, but in every definition the concept of profitability is present. Transcending this, from an overall standpoint, profitability enables the continuance of an organization – and all of the benefits that flow from its existence.

This month I would like to examine a key tool for projecting and examining your profitability – a Break-Even Analysis. But why is this important? There are three benefits to knowing your company’s Break-Even point:

  1. It enables the establishment of the point where you begin to make a profit
  2. It allows you to determine a key piece of your working capital needs
  3. It facilitates business projections and expansion planning

Unfortunately relatively few organizations perform a Break-Even Analysis because they don’t know where to start.

To create a Break-Even Analysis you need three sets of data. You can do this analysis on a monthly, quarterly, or, likeSmall Business Planning in Atlanta most businesses, an annual basis. Additionally, you can do this for a location, region, division or the entire company.

Your Fixed Costs

The first step is to add up your fixed costs for a given period of time (e.g., monthly, quarterly, or annual). Your fixed costs remain constant in the short run; for instance, your rent, insurance, utilities, etc., whereas your Variable Expenses change in relation to the Revenue of your company. See below for an easy way to identify your Fixed Expenses. The total of your fixed expenses is recorded as a horizontal line your Break-Even Analysis electronic spreadsheet.

Your Variable Costs

Second, you need to identify the variable expenses for your business – which are the ones that change in a direct relationship to your revenue. These include your Cost of Sales expenses (which are the expenses that are directly related to the production of your revenue) and any of your overhead expenses that vary with your revenue, such as support staff, supplies, training, etc.

Creating Your Break-Even Analysis

Small Business Planning in AtlantaThe easiest way to identify and separate your Fixed costs from your Variable costs is to print out your organization’s Chart of Accounts and for the accounts in your Cost of Sales and Expenses sections mark an F next to each account that is a Fixed cost and a V next to each account that is a Variable cost. Next, generate an Income Statement for the time period you want to use for your Break-Even Analysis.

Then using your Chart of Accounts noted with F’s for Fixed costs and V’s for Variable costs, transfer these F’s and V’s amounts from your Income Statement, line-by-line to separate Fixed and Variable sections you have created in the electronic spreadsheet that you are using to create your Break-Even Analysis. Next, total all of the F accounts and the V accounts. The total of your F accounts is plotted as your Fixed Expenses.

Then using your Income Statement determine the percentage relationship between the sum of your Variable Expenses in your electronic spreadsheet and your total Revenue. For instance:

For the year ending December 31, 2100

                                                                              Company                            Company

                                                                                      A                                        B

Total Variable Expenses $80,000 $105,000
Revenue $200,000 $300,000
Variable Expense Percentage 40% 35%

Using the Variable Expense percentage that relates to your projected Revenue, plot your Variable Expenses starting at the point your Fixed Expense line intercepts your Y axis and show these increasing at the slope of the percentage relationship between your Revenue and Variable Expenses.

Lastly, with both your X and Y axis using the same scale, plot your revenue starting at zero and show it increasing at constant slope.

Interpreting Your Break-Even Analysis

Once you have plotted these three lines, the point where your revenue line crosses your variable expenses line is your Small Business Planning in Atlanta, Georgiabreak-even point. This is the point where your business neither makes a profit nor losses money.

The difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the left of your break-even point represents the loss your business would incur at various levels of revenue.

Whereas the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the right of your break-even point represents the profit your business would generate at each level of revenue. This is where your Big Money is at.

The lower is the revenue amount at which you reach your break-even point and therefore begin to make a profit, the lower the amount of risk that your business has and the easier it will be to attract investors to your business.

Utilizing Your Break-Even Analysis

As we saw above the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the left of your break-even point represents the loss your business would incur at various levels of revenue. This information allows you to determine how much working capital you would need at the stated level of revenue to offset the drain on your cash because, in fact you are losing money at these levels.

Whereas the difference between your Revenue and your Variable Expenses lines at various levels of Revenue to the right of your break-even point represents the profit your business would generate at each level of revenue. You can use this information to facilitate business projections and expansion planning. This information also shows you the return that you could receive from growing your company to various levels.

Therefore, creating and using a Break-Even Analysis is a crucial tool you can utilize to create a successful business.

If you need assistance with creating and using a Break-Even Analysis please contact us because we can show you how to fully use this tool create an even more successful business and therefore find the big money.

Fountainhead Consulting Group, Inc. is an Innovation and Business Planning firm. During the past 17 years we have shown over 1,200 companies how to achieve the goals for their business by using our unique, comprehensive and systematic business planning and growth methodology, the Structure of Success™ so they can Work Less, Make More and most importantly Have Fun in Their Business. Using our Structure of Success™ methodology each month we examine one of 12 areas of a business or organization.

Office phone: (770) 642-4220

www.FountainheadConsultingGroup.com

George.Horrigan@FountainheadConsultingGroup.com

July 2015 Newsletter – Score Keeping Your Business

Score Keeping Your Business

If you were in our office about a month ago you would have found me in a meeting with Paul, a tall, thin man in his mid-thirties who owns an equestrian business. During the meeting Paul said to me, “late last year I changed the direction of my business…” I said “great, let’s see how you are coming along with the new direction”. In other words, let’s looks at the numbers for your business.

Determining and tracking where an organization is financially at, is the purview of the Finance area of a company. Although some business owners and leaders may find finances unappealing and boring, it is absolutely critical to a business because if you do not pay proper attention to this function, you may run out of money and never achieve the dreams for your company.

Bear in mind the accounting, finances and financial reporting of an entity are not an end in themselves, but strictly a means to an end. In reality the true function of your Finance and Accounting area is it provides the “score keeping” of your business. But what are you keeping score of?

  • Are you on track for achieving the Vision for your company?
  • What is happening with regards to meeting the goals for your business?
  • How are you doing with the execution of your business plan?

Three Score Books

This score keeping function involves different score books:

  • Financial Statements
  • Metrics
  • Ratios

Financial Statements consist of your main two financial statements, an Income Statement and a BalanceSmall Business Planning in Atlanta, Georgia Sheet – that are in turn produced on a periodic basis.

Metrics are the internal measurements of your business’ “systems” that indicate whether or not your systems are operating correctly.

Ratios are measurements that mainly use Financial Statement information to calculate values that are compared to other companies or industry averages.

For our remaining discussion I would like to focus on the first scorebook and lay the foundation to help you to understand what your Financial Statements are telling you about the health of your business.

With regards to your finances there are five main things you want to know about your company:

  • Are you making a profit or loss?
  • Are you managing your assets (Cash, Accounts Receivable, Inventory…) properly?
  • Are you funding your business in the most advantageous way?
  • Do you have the information to make strategic and tactical decisions?
  • How can you operate your business in the best possible manner?

To understand your Income Statement and a Balance Sheet you need to be aware that your Chart of Accounts, which is the foundation of your accounting system, is separated into six different types of accounts, namely:

  • Assets
  • Liabilities
  • Equity
  • Revenue
  • Costs of Sales (or Cost of Goods Sold)
  • Expenses

Balance Sheet

Small Business Planning in Atlanta, GeorgiaFurthermore, your Assets, Liabilities and Equity are shown on the aforementioned Balance Sheet. To understand how the information is presented on a Balance Sheet you have to know that the Assets of a business always equal the sum of your Liabilities plus Equity. Therefore, using algebra, we can determine that when you take a business’ Total Assets and subtract its Total Liabilities, you end up with the business owner’s Equity.

Obviously your Assets (Checking Accounts, Accounts Receivable, Inventory, Equipment…) are good things. Versus your Liabilities (Accounts Payable, Credit Card Payables, Payroll Taxes, Loans Due, Notes Payable…) are generally bad things and your Equity is how much “skin you have in the game”.

Keep in mind that your Balance Sheet shows its information as of a certain date. Therefore, it is like a snap shot picture of your company’s financial health as of that particular date. If you compare your Balance Sheet from one date to another date, you can see how the health of your company has improved or deteriorated in terms of the changes to your Assets, Liabilities and Equity. This is called a Comparative Balance Sheet and it is like having your lab tests done with your periodic physical and then comparing how your Glucose, Cholesterol and Triglycerides, etc. have changed during that time period.

Income Statement

Your second Financial Statement is an Income Statement and it shows your Revenue, Costs of Sales and Expenses. Its formula is your Revenue minus your Costs of Sales and Expenses yields your Profit or Loss which is the final number of the bottom of the Income Statement, hence the term the “Bottom Line”. An Income Statement always shows financial information for a period certain of time, therefore it is like a movie of your Revenue, Costs of Sales and Expenses for that period of time.

When used together your Balance Sheet and Income Statement can be used to assess the overall health of your business and see what the “score” is how you are doing at accomplishing the goals for your business.

Customer Relations Manager

Lastly, there is one other tool that I recommend you use for score keeping in your company and this is aSmall Business Planning in Atlanta, Georgia Customer Relations Manager or CRM for short. While your Balance Sheet and Income Statement tell you very well where you have been and where you are at, they don’t tell you where you are going. Your sales prospects, sales funnel and upcoming sales predicts where you will be at as far as the health of your company. Therefore, we recommend using a CRM, such as the package by Results Software to systematize your Marketing and Sales functions and keep score of how you are doing in this all important area.

In summary, use your Balance Sheet, Income Statement and Customer Relations Manager to understand what the health of your company is and keep score of how you are doing at accomplishing the goals for your business.

If you need assistance with “score keeping” and fully understanding the health of your business please contact us so we can show you how to use this concept to tremendously increase your revenue and take your business where you want it to go.

www.FountainheadConsultingGroup.com

George.Horrigan@FountainheadConsultingGroup.com

Office phone: (770) 642-4220