How To Keep Your Business Financially Strong!
Q: How much above the monthly revenue does a small retail business need to make a month to be considered a financially strong business and worth staying in business? In other words, what should the ratio of overhead to profits be to be considered a healthy retail business? A.J. Lawson Alberta, Canada
This is a very important question with a fairly straitforward answer to keep your business financially strong. What you are talking about here is your profit margin. Any viable business should have a 35-50% profit margin. That means that your “net” receipts after all your expenses should be 35-50% of your total “gross” income. What that comes out to in dollars and cents is something you will have to figure out for yourself or with the help of your accountant. I would encourage you to break that down even further into weekly and daily amounts. This should give you an idea of what you need to bring in each day and week to be profitable. You can then break it down even further to what each employee should be bringing in each shift and helping you build a financially strong business. This is a good way to judge your highest revenue days, hours during the day,or if you have them, if your employees are in the best position for that individual to reach their highest potential (although this should only be one of several criteria when it comes to employee reviews). Please see Chapter 11 &12 of Business Genesis.
Once again, this is much easier if you’ve been in business for a while. In that case, estimate the cost of your goods sold (beginning inventory, goods purchased or manufactured, shipping charges, etc.) and subtract that from your overall sales revenue. If you are just getting started, estimate your profit margin by using what you learned in the last lesson and what is considered standard for your industry. If you do not know what that is, definitely refer to this formula.
- Revenue $100
- Cost of Goods Sold $ 50
- Gross Profit $ 50
- Operating Expenses $ 30
- Operating Profit $ 20
- Taxes $ 5
Net profit $ 15
Take time to readjust figures. Given the estimations for sales and expenses, you most likely will want to go back and readjust your estimates to reach your profit targets. This may mean you purchase fewer new supplies in the coming year or you need to add two new employees. Factor in these adjusted costs and or savings and run the numbers again. You may need to bite the bullet and go to an accountant or business consultant for help with your budget figures. Either way, remember that it’s important to use realistic figures so that your budget can help you guide your business. Remember that budgeting is not an exact science.
Your budget works on common sense. If you made $100,000 last year in revenue, common sense indicates you won’t make a million the next. You are best off estimating in the range of $80,000 to $120,000. However, be prepared to make adjustments to your budget as the year progresses. You may have set your sales figures too high when an economic slump hits your business. Conversely, you may land a client that doubles your business. Creating a monthly or yearly business budget is an essential infrastructure project that gives you the ability to make conscientious financial decisions, so your business can stay on track and grow.
Update Your Budget Monthly
If your budget is going to work for you, plan on revisiting it on a monthly basis with your management team and update it based on your business performance and expenses for the prior month. Take a look at your sales forecast – how’s your pipeline looking? Are there any indicators that you need to make changes to your budget to cover additional inventory or staffing needs? Look at your expenses – are they as projected, or do you need to cut back in certain areas to ensure you stay on track?
Make Changes That Can Have a Positive Impact
Based on your monthly review, make changes to your budget and then wait to see what impact these have to your income and profits by month and by year. For example, perhaps you are under-investing in marketing – adjust your budget and see what happens to your pipeline next month or over a six-month period. In your next review cycle, look to see if you are getting a good return on marketing dollars spent per sales lead. Then use this information to inform future planning decisions about where best to allocate your costs. What about receivables? Are there ways you can speed up your invoicing and payment cycles to keep cash flowing into the business?
Respond to Unexpected Changes
Use your budget to help you adjust to the unexpected. Say, for example, an important client cuts their own budget and reduces the amount of business they do with you. Take a look at your budget and how this reduction in revenue affects your cash flow and for how long –- meaning how long will it take to find a new client to replace that important revenue source and what will it cost you in terms of marketing or hiring costs to help you uncover new business?
Tie Incentives to Budget Performance
A great way to get everyone on-board with the idea of focusing and interacting regularly with your budget is to tie performance bonuses to it. So, at the beginning of the year when you plan your annual budget, set parameters for performance tied to profit, but also other categories such as return on investment in marketing dollars, keeping expenses at or lower than plan and so on. By taking the time to create an accurate budget now, you can give your business the best chance of succeeding in the future.
How to Get You Started!
We know for some of us crunching numbers may not be our favorite thing. Yet, as a business owner it is essential that you have a clear understanding of how your business is doing. What are its strengths and where is there room for growth and improvement? We’ve got you covered!
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