Want to make better business decisions?
Want to make better business decisions? Track these 5 things.
This year we started to provide management reporting services for some of our clients. Management reporting simply means budgeting, looking at actuals and analysing variances to try and understand what's going well and what's not going quite right so that you can change course during the year. We often come across very small businesses though which aren't aren't tracking anything in their business, not setting budgets and targets, and often have a surprise at the end of the year when they find out how well or indeed how badly they've done.
We think it's really important for businesses to understand their finances, and the only way to do this is to have up-to-date records and to review what's happening each month. If you're not doing any analysis of your numbers from month to month a good place to start is to just track one or two things in your business and here are our top 5.
Hopefully you have a sales target for each month. If you don't, let's rewind a bit, you need to set one. Once you've done that you should track whether you've hit your sales target each month. If you have an accounting system it will be easy to pull out the figure for the value of sales that you made, if you don't it will be a bit more of a manual process adding up the invoices that you've raised or the sales you've made through different platforms.
Tracking your sales figures will help you to understand trends in your business, whether and to what extent what you do is seasonal and it will help you plan when you need to spend a bit more money on marketing. If you can, break your sales down by the different products and services that you sell, this will give you great insight into what's performing the best for you.
Gross profit is simply the profit you make when you sell a product after paying the direct costs of making it. Let's say you sell cushions for £25 each, and the costs of the material and the filling (the direct costs) are £10. that means you make a £15 gross profit on each cushion, or 60%. Given that we haven't yet taken account of any of your business overheads, it makes sense that your product or service must make a gross profit, it can't be loss making or how would you ever cover those overheads?
Monitoring gross profit will help you ask questions about whether your direct costs are right. Are they higher than they were last year? Do you need to think about changing suppliers? If one of your products or services has a very low margin compared to others, should you focus more time and energy on selling the others? Should you stop selling this one altogether?
So we know your gross profit, if we take off all of your business overheads you’re left with your net profit. If you're a sole trader net profit is effectively your earnings so you need to be profitable. If you're a limited company, once tax has been paid this is the profit which can be distributed to you as a business owner through dividends so it's important to know how you're doing month-to-month. Knowing your net profit will also allow you to roughly estimate your tax bill, and if you've ever been stung with a high tax bill you weren't expecting, knowing that you can budget for it as you go through the year will no doubt give you a great sense of relief.
This is an important one if you invoice your customers. You may give your customers 30 days to pay your invoices, but that doesn't necessarily mean that they will pay you in that time. Having a good idea of how long your customers really take to pay you can help you to forecast your cash flow much better. Knowing that your average customer takes 60 days to pay, will help you be much more realistic about how much money is going to be in your bank account next month when you decide on whether to splash out on something which has popped up.
It can also help you to review your payment terms, if your average client is taking a long time to pay you might decide to shorten your payment terms, ask for payments in advance for certain services, put people on direct debit, and if your debtor days have crept up over the last couple of months it might highlight to you that your credit control has become a bit lax and that you need to spend a bit more time on the phone chasing your customers.
To work out your debtor days divide the average value of invoices you have outstanding by your annual sales figure and multiply by 365. The aim is for your debtor days to be in line with your payment terms.
Days of cash
This is a really important one. They say that sales are vanity, profit is sanity, but cash is king. And they're not wrong. It's easy for a business to go out of business if it's facing cash flow problems, even if the business is fundamentally sound. So you need to know how long your bank balance is going to last, and this KPI will tell you if you don't sell a single thing ever again, how long your bank balance will last before it runs out.
To work it out, add up all of your monthly overheads, then find out your bank balance and divide it by your overheads. Multiply that by 30 and this will tell you how many days of cash you've got available in the bank. A good benchmark is 90 days or more because if you found out you only have 90 days of cash left in the bank, that would give you time to make a plan about what you were going to do to keep the business afloat.
And that's it. 5 things which are easy to track in your business but will give you a real insight into how your business is doing, which will flag anything you should really be concerned about and which will help you make better business decisions. If you're going to measure just one thing today, I urge you to look at how many days of cash you have available, it's something we’ve seen clients struggle with from time to time and it's important to know when cash balances are low so that you can make a plan and stay afloat.
You can find out more about our bookkeeping services at www.butthebooks.co.uk.